Quick answer: the IRS treats an activity as a business when you run it with a real intention of making a profit, and as a hobby when you do it mainly for enjoyment. There is no single test. The IRS weighs nine factors, including whether you run it in a businesslike way, the time you put in, your expertise and your history of income and losses. A business reports income and deducts expenses on Schedule C and pays self-employment tax. Hobby income is still taxable, but hobby expenses are not deductible under current law.
Lots of side hustles start as hobbies. Someone bakes for friends, then sells at a farmers market. A weekend photographer books a few paid sessions. A crafter opens an online shop to fund supplies. At some point the question comes up: is this still a hobby, or is it a business in the eyes of the IRS?
The answer changes how you report income, whether you can deduct expenses and whether you owe self-employment tax. This guide explains the rules in plain English, walks through the nine factors the IRS uses and shows how to document a profit motive. It is one of our tax-focused guides in the wider library of side hustle ideas, so you can pick a hustle and run it properly from the start.
Sources: Internal Revenue Service, “Know the difference between a hobby and a business,” Here’s how to tell the difference between a hobby and a business for tax purposes (IRS Tax Tip), Publication 535 history and current Schedule C instructions, Internal Revenue Code section 183 and Treasury Regulation 1.183-2, Form 5213 instructions, Schedule 1 (Form 1040) instructions; IRS Notice 2026-10 on miscellaneous itemized deductions after the One, Big, Beautiful Bill. General information, not tax advice. Checked October 2026.
Hobby vs Business: The Short Definition
A business is an activity you carry on to make a profit. A hobby is an activity you pursue for pleasure or recreation, even if it sometimes brings in money. The IRS frames the dividing line around intent: are you trying to earn a profit, and do your actions back that up?
Profit motive does not mean you must be profitable right away. Many legitimate businesses lose money in their early years. What matters is whether you are honestly working toward profit and behaving like someone who wants one.
The rules come from section 183 of the Internal Revenue Code, often called the “hobby loss” rule. Its purpose is to stop people from deducting the costs of personal pastimes against their other income. The detailed factors appear in Treasury Regulation 1.183-2, and the IRS summarizes them on its hobby or business guidance page.
Why the Label Matters for Taxes
The tax treatment of the two categories is very different, and the gap widened after 2017.
| Topic | Business | Hobby |
|---|---|---|
| Where income is reported | Schedule C (Form 1040) | Schedule 1 (Form 1040), as activity not engaged in for profit income |
| Expense deductions | Ordinary and necessary expenses are deductible | Expenses generally not deductible under current law |
| Losses | Can offset other income, subject to limits | Cannot create a loss |
| Self-employment tax | Owed on net earnings of $400 or more | Not owed |
| Retirement plans for the self-employed | Can be available, based on net earnings | Not available |
| Qualified business income deduction | May apply | Does not apply |
Hobby expenses were once deductible as a miscellaneous itemized deduction, up to the amount of hobby income. The Tax Cuts and Jobs Act suspended those deductions starting in 2018, and the IRS notes in Notice 2026-10 that the One, Big, Beautiful Bill made that disallowance permanent. In practice, this means a hobbyist pays income tax on gross hobby receipts with no offset for what they spent. (Cost of goods sold can still reduce gross receipts for a hobby that sells items, so keep those records.)
The one advantage of hobby status is that hobby income is not subject to the 15.3% self-employment tax. For most people actively trying to earn money, though, business treatment is more favorable because expenses count.
The Nine Factors the IRS Uses
The IRS lists nine factors to help decide whether an activity is engaged in for profit. No single factor decides the outcome, and the list is not a score sheet. The agency looks at all the facts together.
1. Whether you carry on the activity in a businesslike manner
Do you keep complete and accurate books? Have you changed methods that were not working? Businesslike operation is one of the strongest signals. A separate bank account, a bookkeeping system and written plans all help.
2. Whether the time and effort you put in show you intend to make it profitable
Regular, substantial time points toward a business. Hiring qualified help can count too, even if you personally spend fewer hours.
3. Whether you depend on income from the activity for your livelihood
Relying on the money suggests a profit motive. Not relying on it does not automatically make it a hobby, especially for side hustlers with a day job.
4. Whether your losses are due to circumstances beyond your control or are normal in the startup phase
Early losses and losses caused by events such as a natural disaster or a sudden market change are viewed differently from years of steady losses with no plan to fix them.
5. Whether you change methods of operation to improve profitability
Raising prices, dropping unprofitable products or trying new marketing shows you are working toward profit.
6. Whether you and your advisors have the knowledge needed to carry on the activity as a successful business
Studying the market, learning accepted business practices or consulting experts supports a business finding.
7. Whether you were successful in making a profit in similar activities in the past
A track record of turning ventures into profitable businesses helps.
8. Whether the activity makes a profit in some years and how much profit it makes
Occasional profits, especially substantial ones compared with losses or the money invested, point toward a business.
9. Whether you can expect to make a future profit from the appreciation of the assets used in the activity
Assets that are expected to rise in value, such as land, can be part of the overall profit picture.
The regulations also mention an element of personal pleasure. Enjoying your work does not make it a hobby. But if the activity has strong recreational appeal and little sign of profit-seeking, the IRS gives that weight.
The 3-of-5-Year Presumption
Section 183 includes a helpful presumption. If an activity makes a profit in at least three of the last five tax years, including the current year, it is presumed to be engaged in for profit. For activities that consist mainly of breeding, training, showing or racing horses, the test is two of the last seven years.
The presumption is a safe harbor, not a requirement. You can still be a business without meeting it, using the nine factors. It also does not lock you in: the IRS can rebut the presumption with other facts, though it shifts the burden.
New ventures can file Form 5213, Election To Postpone Determination as To Whether the Presumption Applies That an Activity Is Engaged in for Profit. This asks the IRS to wait until the end of the fifth tax year (seventh for horse activities) before deciding. Filing it has trade-offs, since it extends the time the IRS has to assess tax on that activity, so it is worth discussing with a tax professional first.
Examples of Hobby vs Business Thinking
These hypothetical sketches show how the factors play out. They are illustrations, not rulings.
- The occasional seller. Someone knits scarves as a pastime and sells a few each year to friends. No records, no pricing plan and no marketing. This looks like a hobby.
- The organized shop. A person sells handmade jewelry online, tracks every sale and supply purchase, raised prices after reviewing costs, and runs seasonal promotions. Even with a small loss in year one, this looks like a business.
- The weekend photographer. A camera enthusiast takes a few paid portrait sessions but spends far more on gear than they earn, keeps no books and has no plan to change. The pleasure element is strong and the profit evidence is weak.
- The reseller selling personal items. Selling your own used clothes or furniture for less than you paid is usually not a business or a hobby. It is a personal sale at a loss, which is generally not taxable. Buying items specifically to resell for profit is different.
How to Show a Profit Motive
If you want your side hustle treated as a business, act like one from day one. The goal is not paperwork for its own sake; it is real evidence that you are running a profit-seeking operation.
- Write a simple business plan. One or two pages on your offer, customers, pricing and how you will reach profit.
- Open a dedicated account. Our guide to a separate bank account for your side hustle covers options.
- Keep books every month. Record income and expenses and save receipts. See how to track side hustle income and expenses for a simple system.
- Price for profit. Know your costs and set prices that cover them. Our guide on pricing side hustle services walks through the math.
- Review results and adjust. Note the changes you make when something is not working.
- Learn the trade. Courses, industry reading and expert advice help support factor six.
- Register where required. A business license, sales tax permit or business name filing shows intent and keeps you compliant.
Reporting Each Type on Your Return
Business income goes on Schedule C. You list gross receipts, cost of goods sold and expenses by category, then carry the net profit to your Form 1040. If net earnings from self-employment are $400 or more, you also file Schedule SE to calculate self-employment tax. Profit counts toward the quarterly estimated tax test as well.
Hobby income is reported on Schedule 1 (Form 1040) as income from an activity not engaged in for profit. You do not file Schedule C or Schedule SE for it.
In both cases, income is taxable whether or not you receive a form such as a 1099-NEC or 1099-K. Our side hustle taxes guide for beginners explains those forms and the basics of filing.
Common Misunderstandings
- “If I don’t make $600, it’s not taxable.” That figure was an old reporting threshold for some forms. It never decided whether income is taxable, and the 1099-NEC threshold rose to $2,000 for payments made in 2026.
- “A hobby can’t owe tax.” Hobby income is taxable. Only the expenses lose their deduction.
- “Losing money makes it a hobby.” Startup losses are normal. The question is whether you are working toward profit.
- “Calling it a business makes it one.” Labels do not matter. Behavior and evidence do.
- “An LLC proves it’s a business.” Forming an entity can help show intent but is not decisive on its own.
Frequently Asked Questions
Frequently Asked Questions
How does the IRS decide if something is a hobby or a business? The IRS looks at whether you engage in the activity to make a profit, using nine factors such as how businesslike your operation is, your time and effort, your expertise, your history of income and losses, and whether you change methods to improve profitability. No single factor decides it.
How many years can a business lose money before the IRS calls it a hobby? There is no fixed limit. An activity that earns a profit in three of five years is presumed to be a business, but you can be a business without meeting that test if the facts show a profit motive.
Can I deduct hobby expenses? Not under current federal law for most taxpayers. The deduction for hobby expenses as a miscellaneous itemized deduction has been suspended since 2018, and the IRS says that disallowance is now permanent.
Do I pay self-employment tax on hobby income? No. Self-employment tax applies to net earnings from a trade or business, so hobby income is not subject to it, though it is still subject to income tax.
What is Form 5213? It is an election that asks the IRS to postpone deciding whether the profit presumption applies until after the fifth year of the activity. It extends the time the IRS has to assess tax, so consider advice before filing.
Does selling things on a marketplace make me a business? Not by itself. Selling personal items at a loss is generally not taxable. Regularly buying or making items to sell for profit usually is a business activity.
The Bottom Line
The hobby or business question comes down to profit intent backed by evidence. If you want to earn money from your side hustle, run it like a business: keep books, use a separate account, price for profit and adjust when something fails. Those habits make tax time easier and give you a solid answer if the IRS ever asks. For complicated situations, a CPA or enrolled agent can review your facts.