Hobby or business: when the IRS says your side hustle isn't a business

A hobby still reports what it takes in, but it cannot deduct what it spends, and it cannot throw off a loss that shelters the rest of what you earn. Everything else about this question follows from that one sentence.

Where each one lands on the return

A business goes on Schedule C, and the costs of running it come off before any tax is figured. An activity you run without any intention of turning a profit puts its income on Schedule 1 of Form 1040, on the line meant for income from an activity not engaged in for profit, and stops there. Nothing about the number of sales, the size of the payouts, or the label a platform prints on your account settles which of the two you are in. Schedule C covers the business side of the return, and selling on Etsy and eBay covers the seller's version of this question.

The factors the IRS weighs

The IRS decides this on several factors taken together, and none of them settles the question on its own. Nine run through the whole discussion. It asks whether you run the activity in a businesslike way; whether the hours and effort behind it point to an intention to make it pay; whether you rely on the money to live on; whether the losses trace back to things outside your control, or are the sort a business of that type normally has while it is getting started; whether you have changed how you operate in an attempt to improve profitability; whether you, or people advising you, hold the knowledge that a successful business of that kind needs; whether you have made money in similar ventures before; whether profits show up in at least some years; and whether the assets the activity uses could appreciate enough to produce a profit later on.

The current IRS page on the subject asks a longer set of questions than this, covering advertising, study, and the pleasure you take in the work. It expands the same ground rather than replacing it.

The profit years that create a presumption

This is the "three of five" people search for. Your activity is presumed to be carried on for profit once it has produced a profit in three of the past five tax years, this year included. An activity given over mainly to breeding, training, showing or racing horses uses a different count: two profitable years out of the past seven. The window only works if the activity stayed substantially the same all the way through it, and a profit year here means the gross income the activity brought in came out above its deductions.

What the presumption buys is worth stating plainly. The IRS presumes the activity is carried on for profit, the not-for-profit limits stop applying, and the deductions stand even for the years that ran at a loss. You can rely on that unless the IRS later demonstrates the presumption does not hold.

The election that buys time

A new activity that has not had time to accumulate profitable years can postpone the argument. Form 5213 is the election, and it puts off any IRS determination on the presumption until the full five years have run, or seven for the horse activities. It has to be filed inside three years of the original due date for the return covering the activity's first year, extensions ignored, or within sixty days of a written notice from the IRS proposing to throw out the deductions.

What a hobby costs on a 2025 return

The income is reported in full. Gross income from an activity like this is what is left once the cost of goods sold comes off gross receipts, so a reseller answers for the margin rather than for every dollar that passed through the account.

The spending is where it hurts. Those costs are miscellaneous itemized deductions, and that whole category is disallowed, so a hobby's expenses produce nothing at all. That is now permanent rather than temporary. The disallowance had an end date at the beginning of 2026 written into the statute, and the 2025 law struck those words, so there is no later year in which hobby expenses come back.

The other half of the limit is the one that costs real money: a hobby's loss cannot be set against your other income. It reaches individuals and partnerships, estates and trusts, and S corporations, though not corporations of other kinds. Self-employment tax belongs to a trade or business, which is a different question again; Schedule C is where that lives.

Looking like a business, and meaning it

If the activity is meant to make money, the record should show it: a bank account of its own, books that are complete and accurate, a written idea of how the thing is supposed to become profitable, evidence that you changed course when it was not working, and notes of the advice you took.

None of that converts an activity you really pursue for pleasure. Several loss years running, paired with a large deduction against other income, is the shape that draws the question in the first place, and what an audit looks like covers what happens then.