Is your creative endeavor a business or a hobby? And why it matters...

Inevitably during tax season, working with artists and creatives who earn money from their work, questions about whether their practice qualifies as a business for tax purposes always come up.

If this is something you’ve been unsure about, you’re not alone. It’s a common question I get from artists and creatives, and the answer has important financial implications.

Here are the basics of what you need to know regarding whether the IRS thinks your creative endeavor is a business or not.

First, how you’re organized does not matter.

Many people think this question only applies to sole proprietors, but in reality, any individual, partnership, or even S corporation is subject to the question, is it a business or a hobby? Here’s why the answer matters:

If your work is considered a business, you:

• Must report any revenue earned as income

• Can deduct ordinary and necessary expenses incurred in the generation of that income (studio rent, supplies, software, etc.)

• Can potentially show a loss in early years that will reduce income from other sources

• Must pay self-employment tax and income tax on any net income (revenue – expenses) you generate from the activity

If it’s considered a hobby, you:

• Must report any revenue generated as income

• Cannot deduct expenses incurred to produce that income

• May not deduct any losses

• Must pay income tax, but not self-employment tax on any revenue you generate

Did you catch that? Either way, business or hobby, if you generate revenue from your work, you must claim it as income. And if your work is deemed a hobby, you cannot deduct any of the expenses you incurred to earn that income* or any losses.

So, how does the IRS determine if your work is a business or a hobby?

While the question of business or hobby is binary, figuring out the answer is more complicated. Essentially, the IRS evaluates your intent (do you want to make a profit?), as well as the behaviors you engage in (are you acting like you want to make a profit?). A few baseline questions that are considered in this determination are:

• Do you operate in a business-like manner (have a separate bank account, actively promote your work, pay sales tax, issue 1099s, etc.)?

• Do you track income/expenses and maintain complete and accurate accounting records?

• Do you make efforts and changes to improve profitability?

• Do you have at least some years of profitability?

If you answered no to these questions and claim business expenses on your taxes, the IRS may audit your return. Should the IRS determine an activity you claimed as a business is a hobby, you will likely owe back taxes, interest, and potential penalties for underpayment.

If you believe your work is a business and not a hobby and want the IRS to agree, start here:

• Open a separate bank account for your work

• Track your income and expenses throughly and legitimately (recording all transactions in accounting software or detailed spreadsheets)

• Make, document, and implement at least one decision per quarter aimed at increasing profitability

• Be sure to pay any required sales tax and issue 1099s when required

You might be wondering, is there anyway to make sure my activity is considered a business? As you know, there are no guarantees when it comes to taxes. However there are a couple things to know: The best way to ensure your work is considered a business is to be profitable. The IRS has a presumption of profit standard which says that an activity will be considered a business if it generates a profit in at least three of the last five consecutive years.

If you’re engaged in the behaviors discussed earlier and reporting a profit for at least three of the last five years, the IRS will generally presume that your activity is a business, unless they can prove otherwise.

If you’re not showing a profit in three of the last five years, it doesn’t automatically mean your work will be classified as a hobby, but it does mean the IRS may decide to audit your business. If they do, they will consider your intent and your actions to determine whether you are running a business or engaged in a hobby.

Postpone the IRS decision

If you’re just starting out, you can also postpone any IRS consideration of whether your activity is a business or a hobby for up to 4 years, by filing Form 5213. This can be useful if you know you will likely not make a profit for a few years and don't want to worry about the IRS making a determination until then.

So, are you running a business or engaging in a hobby? A simple question with a not-so-simple answer and serious implications. If you want help sorting out where you fall (and how to strengthen your position), feel free to reach out.

* The Tax Cuts and Jobs Act (TCJA) of 2018 eliminated taxpayers’ ability to deduct expenses related to a hobby that generated income for tax years 2018 through 2025. Prior to the TCJA hobby expenses greater than 2% of income were deductible as miscellaneous itemized deductions. The elimination of the hobby expense deduction was made permanent in the One Big Beautiful Bill (OBBB) passed in 2025.

This information is provided to assist in understanding information relevant to the determination of whether an activity may be treated as a for-profit business for federal tax purposes. Conforming with the information provided does not guarantee that the Internal Revenue Service (IRS) will agree with the classification of the activity as a business.

Final determination is based on all facts and circumstances, and the IRS may reach a different conclusion upon examination. The taxpayer remains responsible for the accuracy and completeness of all information provided and for maintaining adequate records to support their position.