If you have already stared a business, you know this:
Almost all real businesses don’t start with a fancy business plan, a perfect logo, or a well crafted idea scribbled on a whiteboard.
It’s generally hap-hazard, discombobulated, and fly by the seat of our pants type strategy… before you get your act together. Many serial entrepreneurs I meet with all talk about how the only thing that made everything come together was the sweat equity they put into the project in the early stages. It wasn’t a full commitment at first. They started on nights and weekends after the family were sleeping and out for the night,
They start as a side project. A favor for a friend. A skill you’ve had for years that someone finally paid you for. A small idea that made a little money and then, almost by accident, made a little more.
I’ve spoken with thousands of business owners over the years, and I can tell you this with confidence: almost every successful company I’ve seen began its life as a side hustle. The difference between the ones that quietly fade away and the ones that grow into something meaningful usually comes down to one thing.
They knew when to treat it like a real business.
That moment is rarely obvious. There’s no letter from the IRS. No official milestone that says,
“Congratulations, you’ve graduated.”
Instead, there are subtle signals. Financial, emotional, and legal that tell you it’s time to shift gears.
In this article, I want to walk you through how most businesses actually begin, how the IRS looks at side income, when hobby rules become a problem, and how to think about moving from a sole proprietorship into an LLC. I’ll also talk about something I believe deeply and live by myself: using your day job to fund stability while you build something sustainable on the side.
This is not theory. This is how real businesses are built.
How Most Businesses Really Start
When people think about starting a business, they often picture a clean break. Quitting a job. Taking a leap. Betting everything on an idea.
That’s a great story and a true cinderella story. Unfortunately, for most of us, the glass shoe never fits in the end. It’s also not how most smart business owners do it.
Most of the entrepreneurs I work with didn’t quit their jobs right away. They tested ideas while employed. Validated demand before committing fully. Mitigated risk by using predictable income to reduce pressure and avoid bad decisions.
I did the same early in my career.
A side hustle gives you something incredibly valuable: time. Time to learn, to make mistakes, figuring out if people are actually willing to pay for what you offer.
At first, the money is small. A few hundred dollars. Maybe a few thousand over the year. You report it on your tax return. You move on.
Then something changes.
Clients come back. Referrals start happening without you asking. Income becomes consistent instead of random. You begin thinking about the work even when you’re not doing it.
That’s when the question shifts from “Can I make money doing this?” to “What happens if I don’t treat this properly?”
How the IRS Looks at Side Hustles
From the IRS’s perspective, money doesn’t care about your intent. Income is income. Whether it came from a full-time job, a freelance project, or something you do on weekends, the tax rules still apply.
The IRS divides activities into two broad categories. Businesses and hobbies.
That distinction matters more than most people realize.
A business exists to make a profit. A hobby exists primarily for personal pleasure, even if it occasionally produces income. The IRS doesn’t rely on what you call it. They look at how you operate.
They ask questions like these.
Do you run the activity in a businesslike manner? Are you good at keeping records? Does the business have a separate bank account? Can you create operational changes to improve profitability? Have you shown a profit in recent years? Is your life dependent on the business income?
None of these questions alone decides the outcome. Together, they paint a picture.
If the IRS decides your side hustle is a hobby, the consequences are simple but painful. You still report the income, but your deductions become extremely limited. In many cases, expenses are no longer deductible at all.
That’s usually when people call me. After the damage is done.
The Hobby Loss Rules Explained Simply
The hobby loss rules exist to prevent people from using personal activities to generate artificial tax losses. The IRS doesn’t want someone deducting travel, meals, and equipment for something that was never meant to be profitable.
One of the most misunderstood parts of this area is the so-called “three out of five years” concept.
If an activity shows a profit in at least three of the last five years, the IRS generally presumes it is a business. If it doesn’t, they may presume it’s a hobby. Presume is the key word here. This is not a guarantee in either direction.
I’ve defended legitimate businesses that took longer to become profitable. I’ve also seen “businesses” with occasional profits still classified as hobbies because the facts didn’t support a real profit motive.
What matters most is behavior.
When your side hustle starts generating consistent income, and you begin reinvesting in it, you are signaling intent. That intent should be matched with structure.
When a Side Hustle Stops Being Casual
There’s a moment I see over and over again.
A client tells me, “It’s just something I do on the side.” Then they show me twelve months of steady revenue, multiple clients, recurring payments, and meaningful expenses.
At that point, the risk isn’t that the IRS will ignore the activity. The risk is that you are exposed without realizing it.
When income becomes predictable, the side hustle stops being casual. It becomes something that needs guardrails.
This is usually when people should start thinking about entity structure.
Sole Proprietor by Default
Here’s something many people don’t realize. The moment you earn money on your own, you are already in business. You just didn’t choose a structure.
By default, the IRS treats you as a sole proprietor.
There’s nothing wrong with that early on. It’s simple. It requires no formal setup. Income and expenses flow directly onto your personal tax return.
For very small, low-risk activities, this can be perfectly reasonable.
The problem is that sole proprietorships offer zero legal separation. If something goes wrong, your personal assets are on the line. Your house. Your savings. Everything.
As income grows, so does risk. That risk isn’t always obvious. It can come from clients, customers, contracts, or even a simple mistake.
At some point, simplicity becomes liability.
When an LLC Starts to Make Sense
An LLC is not a tax strategy by itself. I want to be very clear about that. Forming an LLC does not magically reduce your taxes.
What it does do is create separation.
When structured and maintained properly, an LLC can help shield personal assets from business-related risks. It also creates a clear line between you and the activity, which matters for credibility, banking, contracts, and yes, the IRS.
The right time to consider an LLC is usually when income becomes consistent, when expenses are meaningful, or when the activity carries risk beyond inconvenience.
I often tell clients this. If you would be uncomfortable explaining the activity to an auditor without documentation, it’s time to formalize it.
An LLC also creates optionality. It allows you to grow into more advanced strategies later, including an S-Corp election, once income reaches a level where that makes sense.
You don’t need to rush this. You do need to be intentional.
Why Keeping Your Job Can Be a Smart Move
There’s a dangerous narrative in entrepreneurship that glorifies quitting too early. I don’t buy it.
A stable paycheck does more than pay bills. It buys you leverage, lets you make rational decisions instead of desperate ones. In fact, that steady stream of money gives your side business room to breathe.
Some of the best businesses I’ve seen were built slowly, with patience, while the owner remained employed. Health insurance stayed intact. Retirement contributions continued. Stress stayed manageable.
The goal isn’t to escape employment as fast as possible. The goal is to build something sustainable.
When your side hustle can reliably cover its own expenses, contribute meaningfully to household income, and show a clear path forward, then the conversation changes.
Until then, your job can be an asset, not an obstacle.
The Emotional Shift That Matters Most
There’s a non-financial signal that’s just as important as revenue. The simple answer is: responsibility.
When people depend on you for their paycheck. You’re the person clients turn to when they expect delivery. It is your reputation that is tied to the business outcomes. That’s when the side hustle becomes real, whether you like to admit it or not.
At that point, treating it casually becomes risky. Not just from a tax perspective, but from a life perspective.
Structure supports seriousness.
How I Think About the Transition
When someone asks me if it’s time to turn their side hustle into a real business, I don’t give them a revenue number. I ask better questions.
Is the income consistent? Are you reinvesting? Do you have systems, even simple ones? Are you exposed legally? Are you thinking long-term?
If the answer to most of those questions is yes, then it’s time to stop improvising.
That doesn’t mean quitting your job tomorrow. It means aligning your tax reporting, your legal structure, and your mindset with reality.
Ignoring that moment doesn’t save money. It usually costs more later.
Pulling It All Together
Side hustles are powerful. They are where ideas are tested and confidence is built. They are also where mistakes are easiest to make because everything feels temporary.
The IRS doesn’t care if something started as a hobby. They care what it looks like now.
When income becomes steady, when intent becomes clear, and when risk increases, structure stops being optional.
Knowing when to make that shift is one of the most important decisions a business owner makes. It sets the foundation for everything that follows.
Welcome to the New Age of Accounting. Let’s begin.
P.S. If you found this article helpful, you’ll love my new book S-Corp Mastery: How Smart Business Owners Maximize Tax Savings & Build a Lasting Legacy. It’s now live and available in a sleek, easy-to-read PDF version. Grab your copy here
Chris is the Managing Partner at Weston Tax Associates, a best-selling author, and a renowned tax strategist. With over 20 years of expertise in tax and corporate finance, he simplifies complex tax concepts into actionable strategies that drive business growth. Originally from Sweden, he now lives in Florida with his wife and two sons.
