Hobby loss rules: is selling your crafts a hobby or a business?

What the IRS hobby loss rules say

The hobby loss rules come from section 183 of the Internal Revenue Code and its regulations. They decide how the IRS treats an activity you carry on without trying to make a profit. The regulation is blunt: deductions are not allowable under section 162 or 212 for activities which are carried on primarily as a sport, hobby, or for recreation.

In practice that means three things for a maker who sells some of what they make. First, the money still counts: You must include on your return income from an activity, even if you don’t expect to make a profit. Second, the costs do not: the expenses of a hobby are miscellaneous itemized deductions and can no longer be deducted, according to IRS Publication 529. Third, a loss stays inside the hobby. Losses from a hobby aren’t deductible from other income, so a year where materials cost more than sales does not lower the tax on your wages.

A business is treated the other way. You report it on Schedule C (Form 1040) and subtract business expenses that are both ordinary and necessary. If expenses are more than income, you can usually deduct it from gross income, although in some situations your loss is limited. The question the rules turn on is whether you carry on the activity to make a profit.

The limit on hobby losses applies to individuals, partnerships, estates, trusts and S corporations. It doesn't apply to corporations other than S corporations.

The nine IRS factors: hobby or business?

The regulation at 26 CFR 1.183-2 lists the factors the IRS uses to decide whether an activity is engaged in for profit, and IRS guidance tells taxpayers to consider nine factors. The regulation also says that all facts and circumstances with respect to the activity are to be taken into account, and No one factor is determinative. You do not win by counting how many factors point your way.

What you say about your intent matters less than what you do: greater weight is given to objective facts than to the taxpayer's mere statement of his intent. At the same time, a reasonable expectation of profit is not required. The test is whether you entered into or continued the activity with the objective of making a profit.

How the factors read for someone who sells crafts

Most makers start because they enjoy the work, and the rules allow for that. The regulation says the fact that the taxpayer derives personal pleasure from engaging in the activity is not sufficient to make it a hobby if the activity is in fact run for profit, as shown by the other factors.

Losses in the first years are also expected. Under the regulation, losses during the initial or start-up stage of an activity may not necessarily be an indication that the activity is a hobby. The picture changes where losses continue to be sustained beyond the period which customarily is necessary to bring the operation to profitable status and the losses cannot be explained by normal business risks. On the other side, A series of years in which net income was realized would of course be strong evidence of a profit motive.

Your other income counts too. Substantial income from sources other than the activity, particularly when the losses would bring tax benefits, can point toward a hobby. Two examples show the contrast. A maker with a full-time salary who loses money on a craft shop every year, keeps no records and never changes prices fits the hobby pattern. A maker who tracks every sale, drops products that lose money and raises prices to cover materials fits the business pattern, even while the shop is still small.

How to run a craft shop so it reads as a business

None of these steps guarantees a result, because the IRS looks at all the facts. They are the things the factors reward.

1. Keep books from the first sale

   Record every sale, fee, material cost and shipping label. The first factor looks for complete and accurate books and records. A separate bank account makes this easier.

2. Price to make a profit

   Work out the cost of materials, platform fees and your time, and set prices above it. Write down how you set them.

3. Change what does not work

   The regulation names A change of operating methods, adoption of new techniques or abandonment of unprofitable methods as signs of a profit motive. Keep notes when you drop a product, switch suppliers or change where you sell.

4. Learn the trade side

   Read up on pricing, sourcing and selling, or ask people who run similar shops. Then follow the advice you get.

5. Track your hours

   A simple log of time spent on production, listings, customer messages and marketing supports the time and effort factor.

Hobby income tax: how to report it

Hobby income is taxable. If your selling is a hobby, the income goes on Schedule 1 (Form 1040), line 8j for 2025 returns. You cannot subtract what you spent on materials, booth fees or platform fees, because hobby expenses can no longer be deducted.

Example: a maker sells $1,200 of candles at weekend markets in a year and spends $1,500 on wax, jars and booth fees. As a hobby, the full $1,200 is reported as income and the $1,500 is not deducted. If the same activity is a business, the maker reports it on Schedule C, deducts the costs, and can usually deduct the $300 net loss from gross income, unless one of the loss limits in IRS Publication 334 applies. The example assumes no other costs and no inventory left over.

If your selling is a business, you report income and expenses on Schedule C (Form 1040). Publication 334 says people self-employed as a sole proprietor or independent contractor figure their earnings subject to self-employment tax there. You must pay self-employment tax and file Schedule SE if your net earnings from self-employment were $400 or more. The self-employment tax rate is 15.3% for 2025.

Form 1099-K and hobby sellers after the 2025 law

Payment apps and online marketplaces must send a Form 1099-K when your payments for goods total over $20,000 in more than 200 transactions. The One, Big, Beautiful Bill retroactively reinstated the reporting threshold in effect prior to the passage of the American Rescue Plan Act of 2021. A platform still may send you a Form 1099-K with lower amounts.

Card payments work differently. If customers pay you directly by card, you get a Form 1099-K from your card processor no matter how many payments you got or how much they were for.

The form does not decide whether you have a hobby or a business, and it does not decide whether you owe tax. Whether or not you receive a Form 1099-K, you must still report any income on your tax return.

If your shop is new: the profit presumption and Form 5213

Form 5213 explains that an activity other than horse breeding or racing is presumed to be engaged in for profit if its gross income exceeds its deductions in 3 or more of the tax years in the period of 5 consecutive tax years. A new seller who cannot meet that test yet can file Form 5213 to elect to postpone an IRS determination as to whether the presumption applies that an activity is engaged in for profit. The determination is postponed until the close of the 4th tax year for any other activity.

You must file the form within 3 years after the due date of your return for the first tax year of the activity. Filing it automatically extends the period of limitations for tax owed on the activity, so the IRS has longer to review those years. Read the whole form before you file.

Rules vary by state. Your state may treat hobby income and business registration differently from the federal rules on this page. This page is general information, not tax or legal advice. For your own situation, check the IRS pages linked below or ask a tax professional.

Where Nation fits

Questions about the hobby loss rules