For U.S. individual taxpayers, the IRS continues to disallow deductions for hobby-related expenses. Understanding profit motive tests, documentation standards, and the permanence of these rules into 2026 is critical for avoiding tax pitfalls.
The IRS has long drawn a sharp line between businesses and hobbies. If your side activity is classified as a hobby, you cannot deduct related expenses—even if they exceed income. While the Tax Cuts and Jobs Act (TCJA) suspended miscellaneous itemized deductions through 2025, the IRS confirmed that hobby loss deductions will remain permanently disallowed from 2026 onward. This makes documentation and demonstrating a profit motive more important than ever.
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🎯 The IRS Profit Motive Test
To determine whether an activity is a hobby or a legitimate business, the IRS applies the profit motive test. Key factors include:
- Does the activity generate consistent profits?
- Are you keeping complete and accurate business records?
- Do you operate in a businesslike manner (separate accounts, invoices, etc.)?
- Do you rely on this income for your livelihood?
- Is the activity improving based on your effort and expertise?
- Have you had past success with similar ventures?
- Does the activity have elements of recreation or personal pleasure?
Generally, the IRS presumes a business intent if you show a profit in at least 3 of 5 consecutive years (2 of 7 for horse-related activities).
🗂️ Documentation: Protecting Your Case
Strong documentation is essential if the IRS questions your activity. Keep:
- Separate bank accounts for business vs. personal funds
- Receipts and invoices tied to business operations
- Business plans and records of adjustments to improve profitability
- Marketing efforts (ads, online listings, contracts)
Without proper records, the IRS may classify your activity as a hobby—even if you intended it to be a business.
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📅 2026 Permanence: Why It Matters
Before the TCJA, hobbyists could deduct expenses up to the amount of hobby income as miscellaneous itemized deductions, subject to the 2% AGI floor. The TCJA suspended this through 2025—and now, the IRS has clarified that these deductions will remain permanently disallowed after 2026.
This means hobby income will always be taxable, but expenses can no longer offset that income—putting taxpayers at risk of higher effective tax rates.
💡 Strategic Takeaways for Taxpayers
- Operate with a clear profit motive to strengthen your business classification.
- Maintain separate business records and avoid mixing personal expenses.
- Plan for 2026 and beyond—hobby expenses will never return as deductible items.
- Consider restructuring your activity into a business entity for stronger protection.
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📊 Example: Hobby vs. Business
| Criteria | Hobby | Business |
|---|---|---|
| Profit Motive | No genuine intent to profit | Clear intent to earn income |
| Tax Treatment | Income taxable, no expense deduction | Income taxable, expenses deductible |
| Recordkeeping | Minimal or personal-level records | Detailed business records maintained |
| IRS View | Viewed as recreational | Viewed as a for-profit venture |
