Hobby vs Business Test
The IRS uses 9 factors to decide if your side hustle is a real business or just a hobby. That classification determines whether you can deduct expenses. Take this quick quiz to see where you stand.
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Hobby vs Business Test
IRS 9-factor analysis based on IRC Section 183
Do you keep separate books, records, and a business bank account?
Business-like Manner — Reg. 1.183-2(b)(1)
Disclaimer: This quiz provides a general assessment for educational purposes only. The IRS considers the totality of circumstances — no single factor is decisive. Consult with a qualified CPA for personalized guidance on your specific situation.
Understanding the IRS Hobby vs Business Rules
If you sell crafts on Etsy, flip items on eBay, or freelance on the side, the IRS wants to know: is that a business or a hobby? The answer matters because businesses can deduct expenses against income, while hobbies cannot (under current TCJA rules through 2025).
The 9 Factors (IRC Section 183)
The IRS doesn't rely on a single bright-line test. Instead, they evaluate 9 factors from Treasury Regulation 1.183-2 to determine your intent to make a profit:
- Business-like manner — Do you keep books, records, and a separate bank account?
- Expertise — Have you studied the activity or hired experts?
- Time and effort — How much time do you invest?
- Asset appreciation — Could assets used in the activity increase in value?
- Success in similar activities — Have you profited from similar ventures before?
- History of income or losses — The “3 of 5 year” safe harbor test.
- Amount of occasional profits — When you do profit, is it meaningful?
- Financial status — Do you rely on this income?
- Personal pleasure — Is this primarily for enjoyment? (Counterintuitively, enjoyment weakens the business case.)
Why Classification Matters
If the IRS classifies your activity as a hobby, the consequences are significant:
- No expense deductions — Under TCJA (2018-2025), hobby expenses are completely non-deductible.
- Income is still taxable — You report hobby revenue but can't offset it with expenses.
- No loss carryovers — Business losses can offset other income; hobby losses cannot.
How to Protect Yourself
Even if your activity has hobby-like elements, you can strengthen your business classification by maintaining professional practices:
- Separate bank account — Never mix business and personal finances.
- Written business plan — Document your profit strategy with measurable goals.
- Track your time — Log hours spent on the activity.
- Consult professionals — Work with a CPA, mentor, or industry advisor.
Frequently Asked Questions
What is the IRS 9-factor test for hobby vs business?
The IRS uses 9 factors from IRC Section 183 and Treasury Regulation 1.183-2 to determine if an activity is a business or a hobby. No single factor is decisive — the IRS considers the totality of circumstances. This quiz evaluates all 9 factors to give you an overall assessment.
What happens if the IRS classifies my activity as a hobby?
If your activity is classified as a hobby, you cannot deduct expenses against your other income. Under TCJA (through 2025), hobby expenses are not deductible at all. Hobby income is still taxable. This means you'd pay tax on the revenue without any offsetting deductions.
What is the 3 of 5 year profitability rule?
If your activity shows a profit in 3 out of the last 5 tax years, the IRS presumes it's a business. This is a safe harbor, not a requirement — you can still be a business even without meeting this test if other factors support it. For horse breeding/racing, the test is 2 of 7 years.
How can I strengthen my business classification?
Key steps: keep separate business bank accounts and detailed records, create a formal business plan, track your time, consult industry experts, document changes you've made to improve profitability, and maintain professional-looking marketing materials.
Can I take losses if my business isn't profitable yet?
Yes, if the IRS considers your activity a business. Startup businesses often have losses in early years, and that's expected. The key is demonstrating genuine profit intent through your actions — not just claiming losses to offset other income.
Not sure about your classification?
The hobby vs business distinction can be nuanced, especially for activities that blend passion and profit. Book a free strategy session to review your situation with a licensed CPA.
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