What is a hobby vs. a business?

Your business may be subject to US regulations regarding small businesses. According to the US government’s Small Business Administration, a small business is typically defined as:

• Organized for profit
• Has a place of business in the US
• Operating primarily within the US or making a significant contribution to the US economy through payment of taxes or use of American products, materials or labor
• Independently owned and operated, and is not dominant in its field on a national basis

A small business is also typically defined by its number of employees, according to the specific industry standards it operates within. The US government’s Size Standards Tool can help you determine whether your business counts as “small” for government contracting purposes.

What is the US government’s definition of a hobby?

According to the IRS, the primary difference between a hobby and a business is that a business actively tries to earn a profit while a hobby generally does not. It may be important to keep in mind that while you may consider small amounts of money from your hobby as a little extra spare income, the IRS may view it as income in certain circumstances.

How can you turn your hobby into a business?

When turning your hobby into a small business, there are several logistical and financial concerns to consider. As we explain in our guide to starting a business, this could include: 

• Assessing your business idea and Unique Selling Point (USP)
• Conducting market research
• Developing a fully structured business plan and roadmap
• Getting funding from your own financial resources, investors and crowdfunding
• Identifying a location for your business or choosing to operate remotely
• Creating a business name and branding
• Choosing a business structure such as sole proprietorship, limited liability company (LLC), corporation or partnership
• Registering your business
• Getting your federal state and state tax IDs
• Setting up business insurance

The IRS’s checklist for determining whether you have a hobby or a business

In their guide to businesses vs. hobbies, the IRS provides a list of factors to account for when determining if you have a hobby or a business. These include considerations like how you conduct your operations, the motivation behind the activity, whether you and your business partners have prior business knowledge/success and what profits you’re making from the work. To learn more about the IRS’s checklist, visit the IRS website.

The pros and cons of a hobby business vs a small business

If you have a hobby that’s starting to turn a profit, you may be wondering whether it’s time to take the steps towards becoming a small business. However, it could be useful to weigh the pros and cons of doing so before you invest time and money into creating one. 

Here are the pros and cons to consider in a business vs. a hobby.

Hobby pros:

• Flexible and done primarily for enjoyment
• Often less time-consuming than a business
• Typically no need for a business license
• Typically no changes to your tax filing method
• You don’t usually need to track your expenses

Hobby cons:

• Expenses may not be tax-deductible
• Income is not guaranteed or consistent

Small business pros:

• Income is intended and can be consistent
• You may be able to deduct business-related expenses on your taxes
• You may be eligible for small business loans or grants

Small business cons:

• May require more recordkeeping and administrative work
• Must comply with local, state and federal regulations
• Financial risk if the business is not profitable

When to transition from hobby to primary business

So, when does making money from a hobby become a business? According to the IRS, once you begin earning consistent income from an activity, it may be considered a business. 

If your hobby generates enough income that you’re reporting and paying taxes on it, it may be worthwhile to transition to a small business model. Doing so could help you manage finances more effectively, claim allowable expenses and turn your passion into a sustainable source of income.

Steps to consider for turning your hobby into a business

Turning a hobby into a business can be a gradual process. Consider starting by assessing interest and demand, tracking requests or purchases to see if there’s consistent engagement. Keep your work organized with clear systems for materials, inventory or scheduling and experiment with pricing to understand what resonates with your audience. 

In this next section, we explore some practical steps to consider when turning your hobby into a small business.

Step 1: Identify what your unique selling point (USP) is

Make sure there is a demand for what your business will offer and consider what your USPs might be. For example, you might aim to set up a baked goods delivery service that caters to different dietary requirements. You could also bring in more customers by offering a discounted subscription service. 

Step 2: Decide what business structure to use

Decide whether you are going to be the sole proprietor or plan to form a limited liability company. There are pros and cons to each. A sole proprietorship may have fewer compliance requirements, while LLCs may require more. 

However, LLCs may protect your personal assets from debt or lawsuits. For more information on the benefits of sole proprietorship or LLC structures, please visit the U.S. Small Business Administration’s webpage on choosing a business structure.

Step 3: Choosing a name for your business

If you decide to use an LLC structure, it’s useful to choose a business name. Consider registering your business name with your state if you plan to operate under a different name as a sole proprietor, so that no one else can use it.

Your hobby might already have a name, and this might already be familiar to your current customers. Think about whether a rebrand is necessary or whether it is more useful to stay using it for your small business. You might rebrand, for example, if the name of your hobby is too personal or casual for a business. 

Step 4: Plan for compliance

When starting an LLC, you may need to open a separate business bank account. You can use this to track your new business’s income and expenses. Familiarize yourself with compliance regulations and tax rules within your state.

Step 5: Conduct market research and identify your target audience

If your hobby is already quite successful, you may already have an understanding of who your target audience is. However, conducting further market research can help you uncover other audiences you may not have already considered. Consider acquiring new customers through advertising your product, as this helps to get it in front of people who would most benefit from what you offer.

Step 6: Network with other professionals

Through building up your hobby, you might already be known to professionals in your industry. Keep in contact with communities and individuals invested in your product, attend industry events and exchange ideas with other business owners in your local area. Build a following through social media, a website or local events and start small while scaling gradually.  

Step 7: Maintain a work-life balance

Maintaining a work-life balance by setting boundaries and keeping healthy, achievable short- and long-term goals can help you stay focused and interested in your work. 

Step 8: Review your decision to turn a hobby into a business

Regularly check in with your progress to make sure you’re comfortable with your original decision to turn your hobby into a business. Even informal tracking of income and expenses can help guide decisions, and reflecting on your goals ensures your hobby remains enjoyable as it grows.

If you’re not sure about this decision, you can scale back operations, reduce your advertising and marketing spend and work with fewer clients. 

However, if turning your hobby into a business is enjoyable and a success, you may look to expand operations, hire more employees or turn it into a franchise. Consider your track record over the past one or two years, as this can help you decide whether expanding would be a profitable goal.

Turning your hobby into a business may require a plan that includes conducting market research, planning for compliance and registering a name. While hobbies are flexible and are primarily for your enjoyment, businesses are designed to turn a profit. Consider whether there is demand first for your product before making the shift, and take steps to maintain a healthy work-life balance.