If the IRS considers your Etsy business to be a hobby business, you are not allowed to deduct business loss expenses from your income. To avoid being classified as a hobby business, treat your Etsy business like a serious business. Keep complete records of your sales and you must make a profit 3 out of 5 years that you are operating. Being considered a hobby business does not mean you do not have to pay federal or state income tax. It only means that you may not deduct your business expenses.