Quick overview
Running a side hustle creates deductible expenses that reduce your taxable net profit. The IRS allows deductions for costs that are both “ordinary” (common in your trade) and “necessary” (helpful and appropriate). Most sole proprietors report these on Schedule C (Form 1040) and pay self-employment tax via Schedule SE. (IRS: “Deducting Business Expenses” — https://www.irs.gov/businesses/small-businesses-self-employed/deducting-business-expenses).
In my practice advising small business owners and freelancers, I see two common mistakes: poor documentation and misclassifying personal costs as business expenses. Below I summarize what typically qualifies, how to claim items, recordkeeping rules, and common traps to avoid.
How the IRS decides what’s deductible
To be deductible, an expense generally must meet three tests:
- Ordinary: Typical for your trade or business (e.g., a photographer buying editing software).
- Necessary: Helpful and appropriate, not extravagant.
- Directly related to the business: The cost must have a business purpose.
If your side activity is a hobby rather than a business, deductions are limited and cannot create a loss for tax years after the Tax Cuts and Jobs Act (TCJA) eliminated miscellaneous itemized deductions for most taxpayers. The IRS considers facts such as whether you seek profit, the time and effort invested, and past success in similar activities. (IRS Publication 535: Business Expenses — https://www.irs.gov/publications/p535)
Common deductible expense categories (and how to claim them)
- Home office
- Two methods: the simplified method (a standard $5 per square foot up to 300 sq ft) or the actual-expense method (allocating mortgage interest, rent, utilities, insurance, and depreciation). Use Form 8829 if you use actual expenses with Schedule C. See detailed rules at the IRS home office page: https://www.irs.gov/businesses/small-businesses-self-employed/home-office-deduction.
- Must be used regularly and exclusively for business, or as the principal place of business.
- Internal link: For details on qualifying and audits, see our guide to the home office deduction (Home Office Deduction — https://finhelp.io/glossary/home-office-deduction/).
- Supplies and equipment
- Consumables (paper, shipping labels) are fully deductible in the year purchased.
- Computers and other equipment: small-cost items may be deducted immediately; higher-cost items may require depreciation or Section 179 treatment (subject to limits and business-use percentage).
- Vehicle and travel expenses
- Choose either the standard mileage rate (for 2025, check IRS for the current rate each year) or actual expenses (gas, repairs, depreciation, insurance) allocated to business use.
- Keep a contemporaneous mileage log recording date, purpose, start/stop miles, and total miles.
- Internet, phone, and utilities
- Deduct the business portion of your internet and phone. If you use one line for both personal and business, allocate the percentage used for business.
- Marketing, websites, and advertising
- Website hosting, domain fees, online ads, business cards, and promotional materials are deductible in full when ordinary and necessary.
- Professional fees and education
- Fees paid to accountants, attorneys, consultants, and educational costs that maintain or improve skills in your business are deductible. Costs to meet new qualifications or to change careers are more limited.
- Insurance, licenses, and bank fees
- Business insurance, licensing fees, merchant processing fees, and bank charges related to your business account are deductible.
- Start-up and organizational costs
- New side businesses may deduct up to a statutory limit of start-up costs in the first year, with the remainder amortized. See IRS Pub. 535 for limits and timing.
- Health insurance and retirement contributions
- Self-employed health insurance premiums may be an above-the-line deduction for the owner, and contributions to SEP-IRA or Solo 401(k) reduce taxable income (subject to plan rules and limits).
- Self-employment tax deduction and Qualified Business Income (QBI)
- You can deduct one-half of self-employment tax (calculated on Schedule SE) as an adjustment to income on Form 1040.
- The 20% QBI deduction (Section 199A) may apply to qualifying pass-through business income; rules are complex and depend on taxable income thresholds and business type.
Recordkeeping: the single most important habit
Good records both maximize deductions and protect you during an IRS review. Keep:
- Receipts, invoices, and bank/credit card statements for expenses.
- A business bank account and credit card to separate personal and business transactions.
- A mileage log for vehicle deductions with date, purpose, and miles.
- Documentation of home-office square footage and allocation method.
- Year-end profit-and-loss summary to support the Schedule C.
In my practice I recommend using accounting software (QuickBooks, Wave, or even a spreadsheet when you’re small) and scanning receipts to the cloud. For mileage, apps like MileIQ or manual logs both work if kept contemporaneously.
Internal link: For step-by-step tracking tips, see our piece on tracking work-from-home expenses (How to Track Work-From-Home Expenses for Tax Time — https://finhelp.io/glossary/how-to-track-work-from-home-expenses-for-tax-time/).
Reporting: where these deductions appear on your tax return
Most side-hustle deductions are reported on Schedule C (Profit or Loss from Business) attached to Form 1040. Net profit from Schedule C flows to Form 1040 and is also used to compute self-employment tax on Schedule SE. If you use the actual home-office method, complete Form 8829.
If your side work is organized as a partnership or S corporation, reporting and deductible treatment differ—partnerships use Form 1065 and K-1s; S-corp owners report wages and may take business deductions at the corporate level. When in doubt, consult a tax advisor.
Official guidance: IRS Schedule C and Schedule SE instructions — https://www.irs.gov/forms-pubs/about-schedule-c-form-1040
Hobby vs business: why it matters
If the IRS classifies the activity as a hobby, you cannot deduct business losses to offset other income. To be treated as a business, you should have a profit motive, keep records, and operate in a businesslike manner (licenses, marketing, separate accounts). Indicators include whether you run the activity to make a profit and whether you changed methods to improve profitability.
Frequently made mistakes and how to avoid them
- Claiming personal expenses as business: keep personal and business costs separate.
- No records to support deductions: lose the deduction if you cannot substantiate it.
- Improper home office claims: ensure the exclusive-use rule is met for the actual method.
- Using inconsistent methods year-to-year without documentation.
Practical tip from my work: when in doubt, document your business plan, keep meeting notes, and keep months-long records before claiming large deductions. Consistent profit-seeking behavior strengthens your position if questioned.
Practical examples
- A graphic designer subscribes to Adobe Creative Cloud ($600/year). If it’s used 90% for business and 10% personal, deduct 90% of the expense on Schedule C.
- A ride-share driver tracks business miles and decides the standard mileage rate is higher than actual costs; they claim the mileage deduction and retain their mileage log.
Audit risk and safe practices
Home office and vehicle deductions are commonly reviewed by the IRS. Maintain contemporaneous records and reasonable allocation methods. If audited, provide receipts, bank statements, mileage logs, and photos of your dedicated home office space.
See our guide on what the IRS looks for in small-scale home office audits for practical audit-prep steps (What the IRS Looks for in Small-Scale Home Office Audits — https://finhelp.io/glossary/what-the-irs-looks-for-in-small-scale-home-office-audits/).
When to get professional help
If your side hustle grows, you’re unsure about depreciation, QBI eligibility, whether to incorporate, or how to handle multi-state income, consult a CPA or tax attorney. In my practice, a quick planning call often saves clients far more in taxes than the cost of advice.
Final checklist before you file
- Have a Schedule C-ready profit-and-loss statement.
- Separate business and personal bank records.
- Maintain receipts and mileage logs for at least three years (longer if you claim depreciation).
- Review whether you qualify for the simplified home-office method or the actual expense method.
- Consider retirement contributions and self-employed health insurance to reduce taxable income.
Professional disclaimer
This article is educational and reflects common practices and IRS guidance as of 2025. It is not personalised tax advice. For decisions that affect your tax liability, consult a qualified tax professional who can review your situation.
Authoritative sources and further reading
- IRS — Deducting Business Expenses: https://www.irs.gov/businesses/small-businesses-self-employed/deducting-business-expenses
- IRS — Home Office Deduction: https://www.irs.gov/businesses/small-businesses-self-employed/home-office-deduction
- IRS Publication 535, Business Expenses: https://www.irs.gov/publications/p535
- IRS — Schedule C (Form 1040): https://www.irs.gov/forms-pubs/about-schedule-c-form-1040
