Every reseller who's had a slow year has thought some version of "maybe I should just call this a hobby." The IRS doesn't let you choose. Whether your eBay or Shopify selling counts as a business or a hobby is a facts-and- circumstances test the IRS applies regardless of what you check on a form — and a law change that was supposed to soften the hobby side of that test in 2026 got canceled before it ever took effect. The gap between the two classifications is bigger now than it's been since 2017.
The test itself
Section 183 of the tax code — "activities not engaged in for profit" — is what the IRS uses to decide. It's a nine-factor test from Treasury Regulation 1.183-2(b), and no single factor controls:
1. The manner in which you carry on the activity 2. Your expertise, or your advisors' expertise 3. The time and effort you put into it 4. Whether you expect the assets involved to appreciate in value 5. Your success in similar activities in the past 6. Your history of income or losses from this activity 7. The amount of any occasional profits 8. Your overall financial status 9. Whether personal pleasure or recreation is part of it
There's a safe harbor that sidesteps the whole analysis: show a profit in at least 3 of the last 5 tax years (including the current one) and the law presumes you're in it for profit — the burden shifts to the IRS to prove otherwise, rather than the other way around. Miss that bar and you're not automatically a hobby; you just lose the presumption, and the nine factors decide it on the facts.
For most resellers, the factors that actually move the needle are #1 (bookkeeping, a separate bank account, treating it like a business), #3 (real time spent, not sporadic), and #6 (a string of unexplained losses with no attempt to fix it). A slow year or two selling side inventory rarely triggers scrutiny. Years of losses with no separate books, no adjustment to pricing or sourcing, and a day job covering the gap is the pattern that does.
What changed for 2026, and why it matters more now than it used to
Hobby income has always been fully taxable. What changed is what you're allowed to subtract from it. The Tax Cuts and Jobs Act suspended miscellaneous itemized deductions — the category hobby expenses fall into — for tax years 2018 through 2025, with the suspension written to expire automatically after that. Under the law as it stood before mid-2025, hobby sellers were on track to get expense deductions back starting with the 2026 tax year.
The One Big Beautiful Bill Act, signed July 2025, canceled that. It made the suspension of miscellaneous itemized deductions permanent under Section 67(g), with no scheduled return. A hobby classification in 2026 costs the same as it did in 2020 — zero deduction for hobby expenses — instead of the relief that was already on the calendar. If you were planning around "it doesn't matter much if the IRS calls this a hobby, I'll get the deductions back either way," that plan no longer holds.
The one thing hobby sellers still get to subtract — and it's not what people assume
Here's the nuance almost every summary of this topic skips: cost of goods sold isn't treated as a "hobby expense" at all. Courts and the IRS have consistently held that COGS is an adjustment to gross receipts, not a deduction — the same logic in Treasury Regulation 1.61-3 that defines gross income for any merchandising business as sales minus cost of goods sold, and confirmed for not-for-profit activities specifically in Reg. 1.183-1(e). A hobby seller can still net out what they paid for the inventory itself before counting the rest as taxable income. What they can't do is deduct anything else — platform fees, shipping supplies, mileage, subscriptions, a home office — against that income, and the COGS subtraction can't be used to create a loss; it floors at zero.
That distinction is what actually decides how bad a hobby reclassification is for a given seller. Someone whose real expenses are almost entirely cost of goods loses relatively little. Someone whose margin depends on write-offs beyond COGS — fees, packaging, mileage, software — loses all of it.
A worked example
Say a reseller's fourth year running a part-time eBay store shows: $8,000 in gross sales, $6,000 in cost basis on the items sold, $1,800 in eBay fees, and $1,200 combined in shipping supplies, mileage, and a listing tool subscription. It's their third loss year out of four, so the 3-of-5-years safe harbor doesn't apply yet, and this year the IRS opens an inquiry.
As a business (Schedule C): - Gross profit: $8,000 − $6,000 COGS = $2,000 - Minus $1,800 fees and $1,200 other expenses = $3,000 total expenses beyond COGS - Net result: a $1,000 loss, deductible against other income, and no self-employment tax owed on a loss
Reclassified as a hobby: - Gross income: $8,000 − $6,000 COGS = $2,000 (the only subtraction allowed) - The $1,800 in fees and $1,200 in other expenses: not deductible, at all - Taxable income: $2,000 — full ordinary income tax on money that, once every real cost is counted, was actually a $1,000 loss
At a 22% marginal rate, that's the difference between a $220 tax benefit from the loss and $440 owed on phantom income — a roughly $660 swing on this one example, all from a classification question, with the sales, the item costs, and the eBay fees identical in both columns.
What to actually do
- **Keep the business-like paper trail regardless of how confident you are
- in your classification.** A separate bank account, per-item records, and
- a consistent bookkeeping method are evidence for factor #1 and cost
- nothing to maintain.
- If you're several years into losses, document what you changed.
- Adjusting prices, dropping a slow category, or changing where you source
- are exactly the kind of facts that support factor #6 in an actual review —
- losses alone don't sink you, an unexamined pattern of them does.
- Don't assume "hobby" is the safe fallback if scrutiny ever comes up.
- Before mid-2025 it was a soft landing — you'd lose Schedule C but get some
- expense relief back starting in 2026. That relief isn't coming now. A
- hobby finding today means tax on gross income minus COGS only, full stop.
- Track cost basis per item, not a lump-sum average. It's the one number
- that still helps you under either classification, and it's also the
- factual foundation for showing a real trajectory toward profit — a
- business fact, not just a tax number.
Whether the IRS ever asks the question or not, the number this whole test turns on is the same one that determines your real profit day to day: sales minus real cost basis, not a rough guess. PalmFlow tracks cost basis and fees per item automatically as you sell — the same records that support a Schedule C filing hold up if hobby-vs-business status is ever the actual question. It doesn't make that determination for you, and it doesn't file anything. Free plan, 50 items, no card. If you're already filing quarterly as a business, here's what that actually requires.
Disclaimer: this is general information, not tax advice. Whether a specific activity is a business or a hobby depends on the full facts of your situation, and the nine-factor test is applied case by case — talk to a CPA if you're several years into losses or the IRS has actually contacted you about it.