Hobby vs. Business: Tax Implications Explained
If you’ve got a side project — maybe selling handmade goods, freelancing now and then, or running a weekend service — one big question matters: Is this a hobby or a business in the eyes of the Internal Revenue Service (IRS)? Because that distinction changes how you file taxes, what you can deduct, and whether self-employment taxes apply.
The Main Point
If it’s a hobby, you report any money you make (yes, even a little bit) on Schedule 1, Form 1040, line 8j. But you generally can’t deduct expenses for that activity.
If it’s a business, you report income (and can deduct expenses) on Schedule C (for a sole proprietor). You may also need to pay self-employment tax.
So, how do you tell which one you are?
How to Tell the Difference: Key Factors the IRS Uses
Here are some of the questions the IRS asks — they don’t all have to be “yes,” and no one question is a winner by itself — but the more “business-y” things you check off, the more likely the IRS will view your activity as a business.
Do you run the activity in a business-like way? For example: keeping good records, treating it like a business rather than a hobby.
Do you put in enough time and effort to try and make a profit (rather than just doing it for fun or relaxation)?
Have you changed your methods to try to improve profitability (e.g., marketing, better pricing, more efficient operations)?
Do you depend on the income from the activity to help support your livelihood (i.e., you count on it for more than just extra cash)?
Have you made a profit in some years — or do you expect the activity will appreciate (assets increase in value) in future?
Are your losses due to startup costs or other circumstances beyond your control — or are you just chronically losing money with no plan?
Do you have the knowledge or expertise (or are you working with advisers) to run this kind of activity successfully?
Does the activity have a personal pleasure or recreational element (i.e., you do it because you like it) rather than primarily to make money?
One helpful “rule-of‐thumb”: if you’ve made a profit in 3 out of the last 5 years, the IRS will generally presume your activity is for profit (i.e., a business).
What It Means When It’s a Hobby
Let’s say you’re doing something because you enjoy it, you sell the occasional piece, but it’s not really set up for profit — you’ll want to know what the tax impact is.
You must report the income. (Even hobbies that generate some money require reporting. )
You cannot deduct expenses for that hobby activity against other income. That means you can’t use the losses from that hobby to reduce your W-2 income, for example.
Self‐employment tax generally doesn’t apply (because you’re not operating a business).
Example: You make handcrafted jewelry on weekends, sell a few pieces here and there, but you do it largely because you enjoy it and you already have a full-time job. That would lean toward being a hobby.
What It Means When It’s a Business
If you’re treating the activity more as a business — you’re aiming for profit, you’re actively working to improve it, you’re investing time/money — then the tax rules change.
You report income (and expenses) on Schedule C (if you’re a sole proprietor).
You can deduct ordinary and necessary business expenses (inventory cost, marketing, travel, home office if eligible, etc.).
You likely need to pay self‐employment tax on net earnings from that business.
You’ll want to keep good records, a business plan helps, you’ll want to show you’re treating it professionally.
Example: You decide to launch an online shop for your handmade jewelry, you advertise, you hire help, you track your cost of supplies, you aim to turn a consistent profit — now you’re much more in “business” territory.
Why This Matters for You in Texas (and Everywhere)
Whether you live in Dallas, Austin or anywhere else — and whether you’re a full-time pro or a weekend side‐hustler — knowing how the IRS views your activity matters.
It affects how you report your income.
It affects what you can deduct (or not).
It affects what taxes you might owe (including self‐employment tax).
It helps you avoid drawing unwanted attention from the IRS (for example, claiming business losses when really you’re running a hobby).
At Freedom Line Accounting & Tax, we help you clarify this distinction — so whether you’re just having fun or really building a business, you’re set up in the most tax‐efficient, compliant way possible.
What You Should Do Now
Here’s a simple action checklist you and we can go through together:
Review the activity: Are you doing it for profit or mostly for fun?
Keep detailed records of income and expenses — even if you think it’s a hobby.
If it’s becoming more business-like (more time, more investment, more sales), consider treating it as a business for tax purposes.
Talk to us early in the tax year (not just at filing time) so we can help you plan: business structure, self‐employment tax, deductions, bookkeeping, etc.
If it is a hobby: Make sure you report the income correctly (Schedule 1, line 8j) and don’t try to deduct hobby losses.
If it’s a business: Let’s set up a proper system (books/records), plan for deductions, possibly pay estimated taxes if required.
Bottom Line
If you’re in that “grey zone” between hobby and business — you’re not sure where you fall — that’s okay. The key is to be intentional about how you operate: record-keeping, profit motive, business practices. Those move the needle. And whether you’re at one end (just fun) or the other (full-blown business), we at Freedom Line Accounting & Tax are ready to help you navigate it, keep you compliant, and help maximize your tax position.
Have questions about your specific activity or want help reviewing whether you’re hobby vs. business? Book a complimentary consultation today and let us see how we can help!