"Should five per cent appear too small
Be thankful I don't take it all
'Cause I'm the taxman, yeah I'm the taxman"
These are lyrics from the song Taxman, the opening track of the Beatles' 1966 album, Revolver. The song was a response to a supertax implemented by Britain that exceeded 90% for the highest earners. Ultimately the Beatles' savvy accountant, Harry Pinsker created a separate song-writing company taxed as a trading company that served to save the Beatles thousands in taxes.
If you are a creative who earns money from your art, taxes are something you need to be aware of. One issue I see repeatedly is the lack of understanding regarding whether a creative endeavor is a considered a business or a hobby in the eyes of the IRS. While you may think your creative practice is a business, what matters from a tax perspective is how the IRS thinks of your practice.
The tax implications are substantial, so it's important to understand the difference between a creative practice deemed a hobby and one deemed a business.
First, how you’re organized does not matter
Many people think this question only applies to people with no "business structure," or sole proprietors, but in reality, any individual, partnership, or even S corporation that generates income from a product or service is subject to the IRS question, is it a business or a hobby?
Here’s why the answer matters:
If your creative endeavors are 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 those creative endeavors are 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 (in some cases you can deduct cost of goods sold).
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 separate business 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, and the IRS audits your return, it's likely they will characterize the income as hobby income and disallow any and all expenses you have claimed (this means you will owe back taxes, penalities, and interest).
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 business income and expenses separately, throughly, and legitimately (recording all transactions in accounting software or detailed spreadsheets)
Make, document, and implement decisions 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? The best way to ensure your work is considered a business is to be profitable. The IRS has a presumption of profit safe harbor [(IRC) Section 183(d)] 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 take a closer look and 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.