What's the Difference Between Hobby Income and Business Income?

Whether the IRS considers your activity a hobby or a business has significant tax implications. Business income allows you to deduct all ordinary and necessary expenses related to running the business, which can offset your profits and reduce your overall tax bill. Hobby income is fully taxable, but the expenses you incur pursuing the hobby are generally not deductible. The IRS presumes an activity is a business if it earns a profit in at least three of the last five years, but it also considers factors like whether you depend on the income, how much time you invest, and whether you operate in a businesslike way. If your side project is generating real income, keeping good records and demonstrating profit intent can make a meaningful difference in how the IRS views it.