True or False: Are Hobby Expenses Deductible to the Extent of Hobby Income?
Learn how the IRS distinguishes hobbies from businesses and what expenses you can deduct based on your hobby income under current tax rules.
Many people earn money from hobbies, whether selling handmade crafts or offering occasional freelance services. A common question is whether expenses related to these activities can be deducted on a tax return. The answer depends on whether the IRS considers the activity a hobby or a business, which affects how income and expenses are reported.
Hobby vs. Business Criteria
The IRS determines if an activity is a hobby or a business based on intent and profitability. A key factor is whether the taxpayer aims to make a profit. If an endeavor consistently generates income beyond expenses, it is more likely to be classified as a business. The IRS applies the “three out of five years” rule—if an activity shows a profit in at least three of the last five tax years, it is presumed to be a business unless proven otherwise.
Beyond profitability, the IRS looks at how the activity is conducted. Keeping detailed records, operating in a structured manner, and making efforts to increase earnings indicate a business. For example, someone selling handmade furniture who maintains a separate business bank account, advertises their products, and adjusts pricing to improve sales is more likely running a business. Sporadic sales without structured operations suggest a hobby.
The taxpayer’s expertise and time commitment also matter. Specialized knowledge, seeking professional advice, or dedicating significant time to the activity strengthen the case for a business. A photographer investing in professional equipment, attending industry workshops, and actively seeking clients is more likely considered a business owner than someone who occasionally sells photos online.
Deductible Costs
If an activity is classified as a hobby, expenses can only be deducted up to the amount of income generated. Before the Tax Cuts and Jobs Act (TCJA) of 2017, hobby expenses were deductible as miscellaneous itemized deductions on Schedule A, subject to the 2% adjusted gross income (AGI) threshold. However, TCJA eliminated these deductions for tax years 2018 through 2025, meaning hobby expenses are no longer deductible for federal taxes.
Despite this, hobby income must still be reported in full. If a taxpayer earns $3,000 from selling handmade jewelry but spends $4,000 on materials and advertising, they must report the $3,000 in income without deducting the excess $1,000 loss. Business expenses, on the other hand, can be deducted in full and even result in a net operating loss that carries forward to future tax years.
State tax laws vary, with some allowing deductions for hobby expenses even if the federal government does not. Taxpayers should check with their state’s revenue department to determine if any deductions are available.
Reporting Requirements
All hobby income must be reported on a tax return. The IRS requires taxpayers to include hobby earnings on Form 1040, specifically on Schedule 1, Line 8 (“Other Income”). Unlike business income, which is reported on Schedule C and allows deductions, hobby income is taxed in full without offsetting expenses. This can lead to a higher tax liability, especially for individuals in higher tax brackets.
Failure to report hobby income can result in penalties and interest charges. The IRS tracks unreported income through third-party reporting from payment processors such as PayPal and Venmo. Currently, third-party platforms must issue Form 1099-K to individuals receiving over $20,000 in payments and conducting more than 200 transactions in a calendar year. While this threshold may change in future tax years, receiving a 1099-K does not determine whether an activity is a business or hobby—it simply means income has been reported to the IRS. Even if no 1099-K is received, all earnings must still be reported.
In some cases, hobby income may be subject to self-employment tax if the IRS later determines the activity should have been classified as a business. This can result in additional tax liabilities, including Social Security and Medicare taxes. If the IRS reclassifies hobby income as business income during an audit, taxpayers may owe back taxes and penalties.
Recordkeeping Essentials
Maintaining clear financial records is essential when earning income from hobbies. Proper documentation ensures compliance with tax regulations and provides evidence in case of an IRS inquiry. Bank statements, invoices, receipts, and sales records should be systematically organized, with digital copies stored securely.
Tracking all sources of income confirms that the correct amounts are reported. This includes direct sales and related earnings such as commissions, affiliate payments, or royalties. Using accounting software or a dedicated spreadsheet helps categorize income streams, making it easier to reconcile deposits with reported figures. Without clear records, discrepancies may arise, leading to potential penalties or audits.
Expense tracking, while not deductible for hobby activities under current federal tax laws, remains useful for financial planning. Recording costs associated with materials, marketing, and other expenditures provides insight into profitability and can support future business planning if the activity transitions into a for-profit enterprise. Establishing consistent documentation practices early on simplifies the process of reclassification should the nature of the activity change over time.