Hobby or Business? The Rule That Decides Whether You Can Deduct Anything

Last updated August 23, 2026

Quick Answer

The IRS draws a hard line between a hobby and a business, and in 2026, that line costs real money. If your side activity is a business, you can deduct your expenses against your income. If it’s a hobby, you report every dollar you earn and deduct nothing. There is no middle ground. Understanding the hobby vs business IRS rules 2026 is not optional if you’re earning money from a side project, a small shop, or any activity you do partly for fun and partly for income. And if you claimed Social Security early, there is a second rule to know about: how self-employment can cost you benefits before full retirement age.

Key Takeaways

• Hobby income is fully taxable. Every dollar gets reported, no matter what.
• Hobby expenses are permanently not deductible, not in 2026, not going forward.
• The old rule that let you deduct hobby expenses up to your hobby income was suspended in 2018 and made permanently gone by a law signed in July 2025.
• A widely circulated claim that you can deduct 90% of hobby expenses in 2026 is wrong. That 90% figure is from the same law, but it applies to gambling losses, not hobbies.
• The IRS uses nine factors to decide whether your activity is a business or a hobby. No single factor decides it.
• Showing a profit in three of five consecutive years creates a presumption that you’re running a business, but it’s not a guarantee.
• Keeping a separate bank account, clean records, and a simple written plan are the most practical steps you can take right now.
• This article explains the rules. Your specific situation belongs with a tax professional.

What Changed, and Why the Old Rule Is the Trap

Before 2018, someone with hobby income could deduct hobby expenses up to the amount of that income. Those deductions were called miscellaneous itemized deductions, a category on Schedule A (the form used to list deductions instead of taking the standard deduction), and they were subject to a 2% of adjusted gross income floor (meaning only the amount above 2% of your total income counted).

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The Tax Cuts and Jobs Act of 2017 suspended that entire category of deductions for tax years 2018 through 2025. The suspension was originally set to expire, which meant the old rules were scheduled to come back in 2026.

They did not come back.

The One Big Beautiful Bill Act, signed into law in July 2025, made the repeal permanent under Internal Revenue Code Section 67(h). Hobby expenses are now on the permanently disallowed list. There is no sunset date. There is no planned return.

Here is the trap: the pre-2018 rule is the one most people remember. It’s the one that still shows up in old forum posts, old tax guides, and old articles that haven’t been updated. If you search for hobby tax rules and land on something written before 2018, or something that hasn’t been updated since, you may read that you can deduct expenses up to your income. The same staleness problem bit the 1099-K threshold, where AI assistants kept repeating a number that had already changed. That has been wrong since 2018 and is now wrong permanently.

A Wrong Answer That Is Circulating Right Now

Some tax-related websites currently appearing in search results state that for 2026, you can deduct hobby expenses up to 90% of your hobby income. That is not the law.

Here is where the confusion comes from.

The One Big Beautiful Bill Act is a very large piece of legislation. It contains a provision that limits deductions for wagering losses, gambling, to 90% of wagering winnings, beginning in 2026. So if someone spent $1,000 on lottery tickets and won $950, they could deduct $900 of their losses, leaving $50 as taxable income.

That 90% rule applies only to wagering losses. It has nothing to do with hobby expenses.

Both provisions involve the word “loss.” Both appear in the same bill. When a writer, or an AI assistant, works quickly through a large tax bill, it is easy to see a number tied to one provision and attach it to a different one. The result is a confident-sounding answer that is factually wrong.

This is not about blaming anyone. It is about understanding how these errors happen, because the same mistake can come from a human writer or from an AI tool summarizing complex legislation. The lesson is to verify anything you read about tax law changes against a primary source, specifically IRS guidance at irs.gov or the actual text of the law.

How the IRS Actually Decides: Hobby or Business?

The IRS does not use a single test. It looks at the full picture of your activity and weighs nine factors. No one factor automatically makes you a business or a hobby.

The nine factors the IRS considers:

1. Businesslike manner, Do you keep accurate books, maintain separate accounts, and run the activity the way a business would?
2. Expertise, Do you have the knowledge, or have you consulted people who do, to run this activity profitably?
3. Time and effort, How much time do you put in? Do you treat it seriously?
4. Asset appreciation, Could the assets involved (equipment, inventory, intellectual property) increase in value?
5. Success in similar activities, Have you turned a profit in similar activities before?
6. History of income or losses, Is there a pattern of profit, or a long string of losses?
7. Occasional profits, Even if losses are common, have there been profitable years?
8. Financial status, Do you depend on this income, or is it a small add-on to substantial other income?
9. Elements of personal pleasure, Is there a recreational or personal enjoyment aspect to the activity?

The three-of-five presumption

There is a rule of thumb worth knowing: if your activity shows a profit in at least three of five consecutive tax years, the IRS generally presumes it is carried on for profit. For horse breeding, training, and racing, the window is two of seven years.

This presumption matters because it shifts the burden, the IRS would need to prove otherwise rather than you having to prove your case.

But the presumption is not a guarantee. If the rest of the picture looks like a hobby, the IRS can still challenge the classification. Profitability is one data point, not the whole answer.

What the Difference Actually Costs

Here is a plain example using small, realistic numbers.

Say you sell handmade goods and bring in $6,000 for the year. Your costs, materials, listing fees, shipping supplies, total $2,500.

Classification	Income Reported	Expenses Deducted	Taxable Amount
Business	$6,000	$2,500	$3,500
Hobby	$6,000	$0	$6,000

That $2,500 gap is the cost of hobby classification. At a 22% federal tax rate (a common bracket for someone with moderate other income), that difference is $550 in additional tax.

One note: whether the cost of the goods themselves, the raw materials that became the products you sold, is treated differently from other expenses is a question worth raising with a tax professional. Do not assume the answer is the same as for other costs.

What “Businesslike” Looks Like in Practice

The IRS weighs whether you run your activity the way a business would. Here is what that looks like in concrete terms, none of these require a lawyer or an accountant to set up.

A separate bank account. Keep the money for this activity in its own account. This is the single most useful step and usually the easiest to do.

Records kept as you go. Write down income and expenses when they happen, not in a scramble before April 15. A simple spreadsheet works. A notebook works. The point is contemporaneous records, meaning you wrote it down at the time, not reconstructed later.

A simple written plan. A one-page document describing what the activity is, how it is meant to make money, and what you plan to change if it doesn’t. It does not need to be formal. It needs to exist.

Notes on adjustments. When something isn’t working, a product that doesn’t sell, a platform that costs more than it earns, write down what you changed and why. This shows the IRS you are managing the activity toward profit.

A basic log of hours. Time spent is one of the nine factors. Keep a rough record.

These habits are useful regardless of how the IRS classifies your activity. They make tax time easier, help you understand whether the activity is actually profitable, and give you something concrete to point to if you’re ever asked.

One important caution: none of this is about labeling an activity a business in order to claim deductions. The classification follows what you actually do. Doing the paperwork without running the activity as a real business does not change the answer, and the IRS is experienced at spotting that gap.

Why AI Struggles with This Question Specifically

A threshold question, like “what is the reporting limit for Form 1099-K?”, has a number. The risk is that the number is out of date. That is a manageable problem.

Hobby versus business is different. There is no number. The answer depends entirely on your specific facts: your records, your hours, your history of profit or loss, how you run the activity, and whether you depend on the income. An AI assistant cannot see any of that. It will produce a confident-sounding answer based on a general description of the rules, and that answer will leave out the things that actually decide your case.

The 90% error described earlier shows a second failure mode. It is not just that AI misses your personal details. It can also attach a real number from a real law to the wrong provision, especially when a large bill contains multiple provisions that use similar language.

The reusable rule: AI is genuinely useful for understanding what the IRS weighs and what questions to ask yourself. It is unreliable for deciding which side of the line your own activity falls on.

Use it to learn the test. Do not use it as the verdict. That distinction is the whole of the one question worth asking before you take money advice from AI.

Your Next Step

Pick one thing from the businesslike practices above and put it in place this week. The separate bank account is usually the easiest starting point, it takes one trip or one online session and immediately creates a clean record of the activity’s money.

Then, if real money is involved, say, more than a few hundred dollars a year, take the classification question to a tax professional rather than settling it from a search result. The IRS rules on hobby vs business are fact-specific. A professional who can look at your actual situation will give you a far more reliable answer than any article, including this one.

FAQ

Related Reading on Legacy Income Academy

• AI and your taxes when you’re self-employed: what’s safe, and what gets you an IRS notice
• Nobody at Social Security is counting your hours. That is not the same as being safe.
• Making money online after 60: what actually works, what doesn’t, and how long it takes

Source Note

The rules described in this article are based on IRS guidance on determining whether an activity is a business or a hobby, available at irs.gov, and on the One Big Beautiful Bill Act (P.L. 119-21), which permanently repealed miscellaneous itemized deductions under Internal Revenue Code Section 67(h). For your specific situation, consult a qualified tax professional or refer directly to current IRS publications.

This article is educational and does not constitute tax advice. Tax rules can change, and individual situations vary. Confirm your specific circumstances with a licensed tax professional.