The IRS has released new guidance to help taxpayers distinguish between hobbies and businesses for tax purposes, as more Americans earn money through side activities like online selling, content creation, and gig work. The agency’s Tax Tip 2025-42, issued June 24, 2025, emphasizes that the core difference comes down to profit motive — businesses operate to make money, while hobbies are pursued for pleasure or recreation.
This distinction carries significant tax implications. Both hobby and business income must be reported on tax returns, but they’re treated very differently. According to the IRS, anyone who receives payments through apps or online platforms may get a Form 1099-K, and those payments represent taxable income regardless of whether the underlying activity is classified as a hobby or business.
The guidance comes as millions of Americans have launched side activities during recent years, from selling handmade crafts on Etsy to creating content on social platforms. Many are unsure whether their earnings should be treated as hobby income or business revenue, a decision that can substantially impact their tax obligations.
“The biggest difference between the two is that businesses operate to make a profit while hobbies are for pleasure or recreation,” the IRS stated in its recent guidance. However, the agency noted that no single factor determines the classification. Taxpayers must consider multiple elements when making this decision.
Key Questions to Determine Business vs Hobby Status
The IRS provided eight specific questions taxpayers should consider when evaluating their activities. These include assessing whether there’s genuine intent to make a profit, how much profit the activity generates, and whether the person depends on the income for their livelihood. The agency also looks at whether losses are due to circumstances beyond the taxpayer’s control or represent normal startup costs.
Other important factors include whether the activity is run in a businesslike manner with complete and accurate records, whether operations are adjusted to improve profitability, and whether the taxpayer has the knowledge and expertise needed to run a successful business. The IRS also considers whether future profits might come from appreciation of assets used in the activity.
One common misconception the agency addresses is the “three out of five years” profit rule. While the IRS generally presumes an activity is a business if it shows profit in at least three of the last five years, this is just a presumption that can be rebutted based on other factors. Similarly, failing this test doesn’t automatically make something a hobby if other evidence points to genuine profit motive.
Tax Treatment Differences Have Real Financial Impact
The classification carries substantial tax consequences. Business income reported on Schedule C is subject to both regular income tax and self-employment tax of 15.3% if net earnings are $400 or more. Business owners can also deduct legitimate business expenses, potentially reducing their taxable income significantly.
Hobby income, by contrast, must be reported as “other income” on Schedule 1 of Form 1040 but isn’t subject to self-employment tax. However, hobby expenses generally can’t be deducted under current law due to the Tax Cuts and Jobs Act, which suspended miscellaneous itemized deductions through at least 2025. This means hobby income is taxed in full, with no offset for related costs.
If the IRS reclassifies what a taxpayer treated as a business into a hobby during an audit, previously claimed business expenses and losses become non-deductible. This can result in substantial additional tax liability, plus penalties and interest on any underpayment.
Recordkeeping Remains Critical for Both Categories
Regardless of classification, the IRS emphasizes that good recordkeeping throughout the year is essential. This includes tracking all income received, maintaining records of dates and amounts, and keeping supporting documentation for any expenses. For those treating their activity as a business, complete and accurate books and records also support the businesslike manner factor in the IRS evaluation.
The agency’s renewed focus on this topic reflects the growth in digital payments and online marketplaces, which generate more detailed transaction records than in previous years. Payment processors may issue Form 1099-K to users who meet certain thresholds, creating a paper trail that the IRS can cross-reference with tax returns.
Taxpayers uncertain about their classification should consult the IRS publications referenced in the guidance, including Publication 535 on Business Expenses and Publication 334, the Tax Guide for Small Business. The agency’s Activities Not Engaged in For Profit Audit Technique Guide also provides detailed insight into how IRS examiners evaluate these cases.