Hobby or business: What are the IRS hobby loss rules?

Is your side hustle considered a hobby or a business? The IRS distinguishes between hobbies, which are for pleasure, and businesses, which aim for profit, in how tax deductions are handled. If your hobby generates income, certain hobby loss tax rules apply that may reduce your overall tax liability​.

Where hobby loss rules come into play

Many find themselves mistakenly treating hobbies as businesses and might attempt to claim deductions beyond the hobby's income. This common error is exactly what the IRS rules aim to prevent, ensuring fairness and accuracy in tax reporting​.

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On the other side, if you have a small business that hasn’t made a profit in three out of five consecutive years, the IRS might label it as a hobby and disallow any deductions unless you can prove your business is genuinely trying to make a profit. This means keeping detailed records, having a written business plan, and actively looking for ways to improve and increase profits​.

To help determine whether your side hustle is a hobby or a business, consider the following questions:

• Are you actively trying to make a profit?

• Do you keep detailed records of income and expenses?

• Do you have a written business plan?

• Are you consistently making progress toward profitability?

If your answers lean more toward "yes," your side hustle may be considered a business. Be sure to consult with a tax professional for specific guidance on your situation.

What you can and cannot deduct

• Not allowed: Under the current IRS tax code, you cannot claim or deduct hobby-related expenses on your federal income tax return. If your hobby generates income but the IRS deems it hobby income, you can’t deduct expenses against hobby earnings.  

• Allowed: You can deduct hobby-related expenses if that hobby generates business income. In other words, if the IRS deems your hobby is a business, it’s subject to business taxation and you can claim certain expenses. But again – you must accurately determine every year if your earnings are hobby or business income. 

To stay on the right side of IRS guidelines

• Keep diligent records of all your hobby-related expenses and income. This aids in proper tax filing but also helps demonstrate the intent and structure of your activity, whether it be a hobby or a business.

• Understanding the differentiation between a hobby and a business according to IRS standards can also offer more flexibility and benefits if your activity is deemed a business. This is where maintaining a business-like approach to your hobby could turn into a financially beneficial practice​.

If ever in doubt, consult with a tax professional to ensure you follow IRS guidelines and regulations for incorrectly reporting your hobby or side hustle income.

This blog post is provided "as is" and should not be relied upon as a substitute for professional advice. Some content in this post may have been created using artificial intelligence; however, every blog post is reviewed by at least two human editors.