Is My Handmade Shop a Hobby or a Business?

Craft entrepreneurs often start their businesses with very small and irregular sales, so it’s quite common to think it’s more of a “hobby” type of activity rather than a fully fledged business.

It’s easy to find someone on the internet declaring that you don’t need to file taxes until you make a certain amount of money. This is a very popular misconception — the reality is that any online or offline selling activity in which the main motive is to make a profit is deemed by the IRS to be a business, no matter how much you are making in revenue.

Here is what the IRS says:

An activity qualifies as a business if your primary purpose for engaging in the activity is for income or profit, and you are involved in the activity with continuity and regularity.

In other words: if you make products to sell for profit and you do it consistently, you’re a business — whether you feel like one or not.

What’s the difference between a hobby and a business?

A hobby is an activity you pursue primarily for personal enjoyment, while a business is an activity you carry out with the genuine intent to earn a profit.

For tax purposes, the distinction matters enormously. The IRS doesn’t just take your word for it — they look at the facts and circumstances of your situation. And the default assumption, once you’re selling handmade products and reporting income, is that you’re running a business.

To illustrate the difference: say you bake cakes in December and sell them to friends and family at exactly what it cost you to make them. You’re not trying to profit, and you only do it once a year. That could conceivably be argued as a hobby activity.

But if you sell cakes throughout the year at a markup — with the goal of covering your time and growing your income — that’s a business. It doesn’t matter how many cakes you sell or how much profit you actually made. Profit intent is what counts.

Keep in mind that the onus is on you to demonstrate your classification. If you want the IRS to accept that you’re running a hobby (not a business), you need documentation that supports that. If you’re running a business, you want records that prove it.

The 9 IRS factors for hobby vs. business (2026)

The IRS uses nine factors under IRS Publication 535 to determine whether an activity is a hobby or a legitimate business. No single factor is conclusive — they look at the full picture.

1. How businesslike are your records? Do you keep accurate books? Do you have a separate business bank account, track your inventory, and document your material costs? Makers who treat their finances professionally send a clear signal that they’re running a real operation.

2. Do you depend on this income? If the income from your selling activity is your primary livelihood, or a meaningful part of how you support yourself, the IRS is more likely to view it as a business.

3. How much time and effort do you put in? Consistent work — developing new products, improving your process, investing in equipment or skills — signals business intent. Occasional tinkering does not.

4. Have your assets increased in value? For some activities, the IRS considers whether the assets themselves appreciate, even if current income is low. For handmade sellers, this factor is rarely the decisive one, but it contributes to the overall picture.

5. Have you had success in similar activities before? Previous experience running a profitable business in a related field adds weight to the argument that this activity is also a genuine commercial venture.

6. What’s your profit history? This one carries real weight. If you’ve been profitable in at least 3 out of the past 5 consecutive years, the IRS applies a “safe harbor” — they presume you’re running a business unless they can prove otherwise. (More on this in the FAQ below.)

7. Have you made profits in some years? Even inconsistent profitability suggests commercial intent. The IRS looks at the magnitude of your profits and losses relative to your investment, not just whether you’re in the black right now.

8. What’s your broader financial situation? If you have substantial income from other sources and use this activity to generate consistent tax losses, the IRS may look more closely at whether you have a genuine profit motive — or whether you’re offsetting income from elsewhere.

9. Is there a personal element to the activity? Some activities are inherently enjoyable — pottery, jewellery-making, painting. The IRS acknowledges this openly. But a personal enjoyment element alone doesn’t make something a hobby if you’re clearly trying to run it as a business.

The key insight from all nine factors: you don’t need to be profitable yet. Many legitimate businesses run at a loss in the early years. What matters is that you intend to make a profit and are conducting yourself accordingly.

What are the tax implications?

Businesses can deduct ordinary and necessary expenses, report losses against other income, and track material costs through COGS; hobby sellers owe tax on their full income with no ability to deduct costs.

That gap is significant, and it’s worth understanding clearly.

As a business, you can:

• Deduct ordinary and necessary business expenses (materials, tools, subscriptions, marketing)
• Report losses that offset other income on your return via Schedule C
• Claim COGS (cost of goods sold) to reduce your taxable profit
• Deduct a portion of self-employment tax on your return

As a hobby, your options are far more limited.

Hobby income is still taxable — you must report it. Under the Tax Cuts and Jobs Act of 2017, hobby expenses became non-deductible for tax years 2018 through 2025. That meant if you were classified as a hobby, you owed tax on your full income with no write-offs for materials, tools, or any other costs.

For 2026 and beyond, the TCJA provision that suspended hobby deductions was scheduled to expire at the end of 2025. The current status depends on whether Congress extended those provisions — which is exactly the kind of thing that changes between a blog post being written and you filing. Check with a qualified tax professional for your specific filing year.

What doesn’t change: the gap between hobby and business treatment is wide enough that most makers are better off establishing themselves as a legitimate business from the start.

Why material costs are the real sting

This is why claiming your materials as simple expenses is often a mistake.

Say you buy $1,000 of materials in your first year and make $50 in sales. As a business, you track material usage via COGS — so you’re only recognising the cost of what you actually sold. The remaining materials carry forward as inventory.

As a hobby (during the years when hobby deductions were suspended), you couldn’t deduct anything beyond the $50 you earned. $950 in material costs — gone, with no tax relief. The more seriously you stock up at the start, the more this hurts.

When should you officially become a business?

Most makers should formalise sooner than they think — once you’re pricing to make a profit and buying materials regularly, the IRS would likely classify you as a business anyway.

The most common trigger is realising you have consistent sales and a genuine intent to grow. But there are earlier signals that suggest it’s time to take the step:

• You’re pricing to make a profit, not just recovering costs
• You’re buying materials on a schedule and reordering when stock runs low
• You’ve opened a separate bank account or kept selling income distinct from personal funds
• You want to deduct legitimate business expenses at tax time rather than paying tax on gross income

You don’t need to form an LLC or hire an accountant on day one. For most makers, the first step is simply deciding to treat your handmade shop as a business: keep proper records, track your costs, and report your income and expenses correctly on Schedule C.

That shift in mindset — from “I sell things sometimes” to “I run a business” — is exactly what the IRS 9-factor test is designed to detect.

For a detailed walkthrough of what that means at tax time, read the complete guide to Schedule C for handmade sellers.

How Craftybase helps you track from day one

If you want the IRS to see you as a business, start acting like one from the beginning — and for a handmade seller, that specifically means keeping businesslike records of your materials, production, and costs.

This means:

• Tracking the materials you purchase and how much you use per product
• Knowing your accurate cost per unit (COGS) before you price
• Keeping production records that support your business claims at tax time
• Having the data to complete Schedule C Part III without guesswork

Craftybase is built specifically for makers who manufacture what they sell. It tracks your raw material inventory, calculates your COGS per product automatically as you manufacture, and generates the reports you need at tax time — without spending your Sunday nights in spreadsheets.

This is the transition the IRS is actually looking for: a maker who tracks their numbers like a business owner, not someone who “does it for fun.” Starting inventory and cost tracking from day one is one of the clearest signals — to yourself and to the IRS — that you’re running a legitimate operation.

Ready to make that shift? Try Craftybase free and get your inventory and costing in order from the start.

Once your records are in place, the next question is whether your prices actually cover your costs and leave room for profit. Our guide to how to price handmade items walks through the framework makers use to get this right.

Frequently Asked Questions

Please note that tax laws change frequently. This information is for educational and informational purposes only and should not be construed as tax or legal advice. Please consult a licensed financial expert in your area with specific questions or concerns.