If you operate an unincorporated for-profit business activity that generates a net tax loss for the year, you can generally deduct the loss on your federal income tax return. That means the loss can be used to offset income from other sources and reduce your federal income tax bill accordingly. On the other hand, the tax results are not good if your money-losing activity must be treated as a not-for-profit hobby.
Before the Tax Cuts and Jobs Act (TCJA), you could potentially deduct hobby-related expenses up to the amount of income from the hobby. However, you had to treat most of those expenses as miscellaneous itemized deductions that could only be written off to the extent they exceeded 2% of Adjusted Gross Income (AGI). Also, if you were a victim of the dreaded Alternative Minimum Tax (AMT) for the year, your otherwise-allowable hobby deductions could be completely disallowed under the AMT rules. To make matters worse, you had to report 100% of hobby-related income on your return.
For 2018–2025, the TCJA eliminates write-offs for miscellaneous itemized deductions that under prior law were subject to the 2%-of-AGI deduction threshold. This change wipes out all deductions from hobby activities other than expenses that can be written off in any event (such as home mortgage interest and property taxes). So, under the new law, most hobby-related deductions are completely disallowed for regular tax purposes as well as for AMT purposes. You still must report 100% of hobby-related income on Form 1040. Not good! Expect IRS auditors to focus even more attention on taxpayers with money-losing activities.
Business status is good for tax purposes; hobby status is bad, especially after the TCJA. The business-versus hobby issue has been a hot button for the IRS, and the TCJA only adds fuel to the fire. If you’re participating in an activity that is losing money, it’s more important than ever to establish that the activity is an active business that has not yet become profitable.