Many taxpayers earn income from side activities, whether as a hobby or a business. Understanding the difference is important, as it impacts how you report your income and which deductions you can claim.
The IRS looks closely at one main question: Do you genuinely intend to make a profit from your activity?
Hobby vs. Business: What’s the Difference?
A business is generally run with the goal of making a profit.
A hobby, on the other hand, is typically pursued for personal enjoyment or recreation.
Even if your activity brings in some income, it may still be considered a hobby if making a profit is not your main objective.
Why does this distinction matter?
If your activity qualifies as a business, you can generally deduct related expenses, following IRS guidelines. If it’s considered a hobby, you still need to report the income, but your ability to deduct expenses is much more limited.
Key Factors the IRS Uses
The IRS does not rely on a single test to make this determination. Instead, it looks at the full picture of your activity.
Here are some important factors to consider:
Profit Intent and Results
- Do you intend to make a profit?
- Does your activity actually generate a profit, and if so, how frequently does this happen?
- Is there potential for the assets you use in your activity to increase in value over time?
Financial Dependence
- Do you depend on the income from this activity to support yourself?
Operational Approach
- Are you managing your activity in a businesslike way?
- Are you keeping thorough and accurate records of your activity?
- Do you make changes to your operations to help improve profitability?
Expertise and Effort
- Do you or your advisors have the expertise needed to operate your activity successfully?
- Are you putting in the time and effort required to make your activity profitable?
Losses and Circumstances
- Are any losses you experience due to startup costs or circumstances beyond your control?
Important:
No single factor will determine the outcome. The IRS considers all the facts and circumstances together.
Income Reporting Still Applies
No matter how your activity is classified, you are still required to report any income you earn.
- Hobby income should be included on your individual tax return.
- Payments you receive through online platforms or apps may also be taxable.
If you are involved in digital asset transactions, these may also require reporting to the IRS.
- Form 1099-DA reports proceeds from digital asset transactions handled by brokers.
Recordkeeping Is Critical
Keeping accurate records is essential to support your position if questions arise.
Be sure to track the following:
- Income received
- Expenses related to the activity
- Any documentation that demonstrates your intent to operate as a business
Having strong documentation can help support your classification if the IRS reviews your return.
Bottom Line
The distinction between a hobby and a business has a real impact on how you report your income and claim deductions.
Be clear about your goals and intentions for your activity, operate your activity consistently and with purpose, and keep thorough documentation along the way.
Sources
“Here’s How to Tell the Difference Between a Hobby and a Business for Tax Purposes.” Internal Revenue Service, 13 Apr. 2022, https://www.irs.gov/newsroom/heres-how-to-tell-the-difference-between-a-hobby-and-a-business-for-tax-purposes.
“Know the Difference Between a Hobby and a Business.” Internal Revenue Service, Oct. 2022, https://www.irs.gov/newsroom/know-the-difference-between-a-hobby-and-a-business.
“About Form 1099-DA, Digital Asset Proceeds From Broker Transactions.” Internal Revenue Service, 20 Jan. 2026, https://www.irs.gov/forms-pubs/about-form-1099-da.
