Imagine that you enjoy knitting in your living room in your spare time. Occasionally, you put up a few sweaters for sale on eBay or travel to the local farmers market to make a few dollars. You’ve got a few bucks coming in and you greatly enjoy the pastime. But, you’ve never really considered your knitting hobby a business. Perhaps you should. The Canada Revenue Agency (CRA) applies certain criteria to interests that resemble hobbies, yet technically qualify as businesses. The amount of income received versus expenses incurred determines whether the CRA sees your part-time activity as a hobby or business. Consider the following tests to figure out how to categorize your hobbies.
The Profit Test
The CRA uses the profit test to gauge whether the income received from a hobby should be treated as business income. For example, if you’re knitting sweaters for fun and the amount of money you receive is much less than the materials you purchase to make them, the hobby designation still stands. However, if your expectation is to turn a profit, then any income received from the pursuit must be reported on Form T2125 or the Statement of Business or Professional Activities. This form is part of the T1 income tax return bundle. The income from a perceived hobby is considered taxable, especially if a history of profit can be shown through the years.
To Report or Not to Report
If you have concerns about reporting hobby income on your tax return, it’s a good idea to review the CRA publication — Application of Profit Test to Carrying on a Business. This document lists further guidelines that will help clarify how you need to classify your earnings. Among the things the CRA looks for is how much time you regularly spend on your hobby. For example, is it 20 hours per week or a few hours per month? A hobby that takes on the time commitments of a part-time job likely holds itself out to be a business, especially when income exceeds expenses.
The CRA also looks at the financial resources you commit to your hobby. Is it strictly a labor of love with a few dollars being invested from savings? Or are you borrowing money to finance the operation? In the case of the latter, the CRA considers such activity to be a sign of expansion where the expectation of turning a profit is evident. In this case, you may want to report proceeds on the T2125.
The Upside to Taxes
For every hobby classified as a business, the same tax advantages apply. While you might disagree that your relaxing activity is actually a business, you are also entitled to the same deductions that any other Canadian small business enjoys. If applicable, you can deduct home business expenses or entertainment costs that would normally not apply to income from your day job. You may even end up paying less tax than the year before.