Entrepreneurism isn’t an easy path — there is no real safety net to catch you if the business doesn’t work out. So unless you have a massive amount of capital saved up, or some seriously generous investors, chances are good your small business is going to start out as a small side project.
And that’s perfectly fine. In fact, I’d recommend you keep your day job until you have enough saved to support yourself, your family, and your fledgling business for five or six months without turning a profit.
But there is a point at which your side project becomes a small business, and knowing when that happens will make planning your next move, and staying on top of your obligations, much easier.
1. When net earnings exceed $400 a year
I know, $400 is not a lot of money. But, from the IRS’s perspective, that is when your side project turns into self-employment. And that’s when you need to start reporting self-employment income. Form 1040 does list a few other conditions, but for most new business owners, the $400 net-earning threshold is what will be triggered first. Unfortunately a lot of new entrepreneurs assume that they don’t have to report anything until they’re making real money. That is not the case, so don’t forget to report that income — tax penalties can be deadly to a new venture.
2. When you’re focusing on profitability
The IRS does distinguish hobbies from businesses. And when you’re first starting out, it can be easy to chalk your company up to a hobby. That’s perfectly fine as long as you’re unprofitable, but once you begin to change how the business is run to drive up profit, it isn’t a hobby anymore.
Once you begin to focus on making a profit, it isn’t a hobby anymore.
The official rule is once your side project makes any sort of profit for three years out of five, it’s a business, and that is when you can count your losses as deductions. Startup costs are actually deductible, so it behooves you to treat your side project as a business, and to focus on driving up profits, earlier rather than later.
3. When it’s eating into your day job
Like I said before, you do not want to quit a steady job to focus on running your business until you have a nest egg saved up, or some serious backing. The problem is, once business starts to pick up, you might find yourself working on your new company during your job. And I guarantee, at some point, your work will start to slip.
You don’t want to lose your job or burn any bridges. If you’re finding that you can’t run your company solely during off-hours, consider asking for fewer hours, at least temporarily. That way you can experiment with dedicating more time to your new venture, without having to go all in. Pace yourself, and know your limitations.
Make a smart transition
Starting your own business is frightening. A lot of new entrepreneurs have never had to strike out on their own, and adjusting to a less stable lifestyle is difficult. But knowing when your side project becomes your small business is an important step in making that transition.
Treat your business like a start-up early on, focus on profitability, and stay on top of your legal and financial obligations. Then you can start testing the waters before diving in. Before you know it, that fun little hobby you used to do on the side will be your full-time job.
The above content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.