You can set up a hobby as a business and deduct your losses. However, you must be able to prove that the hobby is a for-profit business. If you realize some profit in at least three out of the most recent five consecutive years, it is presumed that the business is for profit. But even if you don’t show a profit, you may be able to prove that the business is intended to make a profit. To prove that you have a profit motive in conducting your business, keep detailed records. Present evidence of your advertising campaigns, attempts to generate new business and sales analyses. It’s not necessary to show that you run a big business, but only that you have genuine intentions of running the business in a business-like way.
The taxpayer reduced their taxable income by $5,000 by setting up a hobby as a business and showing a loss. Since the taxpayers income was taxed at the 30% tax bracket, the income reduction may decrease their income taxes by $1,500 ($5,000 x 30%).
If you are in a combined (federal, self-employment, and state) tax bracket of 30%, you could reduce your taxes up to $300 for every $1,000 of income reduction by setting up a hobby as a business and showing a loss.