What if you could make money from your hobby? Good news! Plenty of businesses and side-hustle projects are born out of simple hobbies and interests.
It seems like an ever-increasing number of people are running a side-hustle business in their spare time too, covering anything from woodwork crafts to graphic design and everything between the two. For some people it’s a way to earn extra income from a hobby that they already love, or even to test the waters before committing to self-employment.
When does a hobby become a business?
Starting a side business based on a hobby is a good way to test out whether the entrepreneurial life is for you, and whether your hobby is profitable. In very general terms, your hobby is a business if you sell your products or services, and the income that you receive from doing so is more than £1,000 in a tax year. This £1,000 threshold is what’s known as the Trading Allowance.
What is the tax free trading allowance?
HMRC introduced it as a tax free allowance to cover “self-starters” with small, hobby-based businesses. It means that you can earn a total of £1,000 from self-employment in a tax year, before you even need to report it to HMRC or pay tax on the income. Note that we say ‘a total of’ – if you have multiple side-hustles (which is allowed), you won’t get a separate Trading Allowance for each one!
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What if I earn more than the tax free allowance?
If you’re making enough to go over the £1,000 threshold in a tax year, well done! Sadly, it’s also time to tell HMRC. Failing to register a business when you should do so usually means financial penalties and an array of backdated tax payments.
Will HMRC know if I earn more than the trading allowance?
Depending on how you receive your self-employed income, HMRC might find out about it whether you tell them or not! The digital platform reporting rules mean that the income received by some online sellers will be automatically reported to HMRC at the end of each year.
For instance, if you sell on Etsy then this information may be shared to HMRC, but that doesn’t necessarily mean you need to do anything differently as long as you’re complying with the tax reporting rules!
Learn more about what the digital platform reporting rules mean for your side hustle.
What business structure should I choose for my side-hustle?
The term side-hustle doesn’t actually indicate a legal structure, so you’ll need to choose one when you register your business. The pros and cons of each depend on your circ*mstances, so do a bit of background reading or chat to an accountant or business mentor before deciding anything.
By far the most common route for people running a side-hustle is to register for Self Assessment as a sole trader. This is very simple to set up, there isn’t a fee, and your information won’t be made publicly available like it would be if you were to register a limited company. But, as always, it’s important that you choose the structure which is best for you!
The Trading Allowance if you register as a sole trader
It’s worth noting that if you do become a sole trader, you might still be able to use the Trading Allowance to claim tax relief against your income. Basically, you’ve got two choices:
- Deduct the £1,000 allowance from your gross income and pay tax on the remaining, or;
- Deduct allowable expenses from your gross income, like businesses usually do, and pay tax on the profits that are left
It’s up to you which one you choose, but you can only use one method at a time. You might want to work out which one is most tax efficient for you. If you total all of your expenses and they are less than the trading allowance, using your trading allowance against tax will be more beneficial.
Should I turn my hobby into a business?
Doing something you love as a business is a completely different experience to doing it for fun. Running a business means taking into consideration profitability, expenses, tax, marketing and admin, on top of whatever you’re planning to sell. Plus, if your motive is to sell things to make a profit, or your sales are consistent or ongoing, then you may need to pay tax on what you sell.
We know it sounds a bit scary, but that doesn’t mean that it’s impossible. As online accountants, we’ve put together some advice on how you can turn your hobby into an HMRC-compliant business start-up.
Log all of your business transactions
When you start to do regular work it’s important to create bookkeeping records which log all your transactions so that your income, and therefore tax, is clear and accurate.
With simple bookkeeping software like Pandle, this is as easy as linking the software to your bank account so that transactions can be pulled over automatically. Some people also find it useful to open a separate bank account for their business, making it much easier to differentiate between business and personal transactions.
Claim your allowable expenses
Businesses pay tax on the profits that they make, so claiming your expenses reduces the amount of profit, and therefore the amount of tax which is due.
An example of how expenses work against tax
A hairdresser charges £20 to colour someone’s hair. The hairdresser spent £5 buying the dye. This means that the hairdresser has made £15 in profit, because £20 – £5 = £15.
They will pay income tax at a rate of 20% on the profit.
The hairdresser pays income tax on £15 (£15 x 20% = £3 tax) rather than on the full £20 (which would work out as £4 tax).
Now multiply that by all their customers, or for more expensive purchases. In some cases this difference can be really very significant!
Read our guide to the differences between operating as a sole trader or a limited company to help you decide which one suits you best, or chat to the team for help. Call 020 3355 4047, and get an instant online quote.
