Are You Enjoying a Hobby – or Running a Business?

Posted by Bruce Mc on Oct 26, 2010 in Information | 0 comments

Why It Matters

Millions of Americans use hobbies to relax and take their mind off work. But hobbies that turn a profit – such as sewing, woodworking, fishing, gardening, stamp and coin collecting – may actually be considered businesses by the IRS.

So, when does a hobby become a business and how does that change the tax implications?

Definition of a Hobby vs a Business

The IRS defines a hobby as an activity that is not pursued for profit. A business, on the other hand, is an activity carried on with the reasonable expectation of earning a profit.

The tax considerations are different for each activity – so taxpayers should determine whether an activity is engaged in for profit as a business, or is engaged in as a hobby.

Of course, you must report and pay tax on income from almost all sources, including hobbies. But when it comes to expenses and losses, the two activities differ in their tax implications.

Note: Internal Revenue Code Section 183 (Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the “hobby loss rule.”

Is Your Hobby Actually a Business?

If you’re not sure whether you’re running a business or simply enjoying a hobby, here are some of the factors you should consider:

• Does the time and effort put into the activity indicate an intention to make a profit?
• Do you depend on income from the activity?
• If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
• Have you changed methods of operation to improve profitability?
• Do you have the knowledge needed to carry on the activity as a successful business?
• Have you made a profit in similar activities in the past?
• Does the activity make a profit in some years?
• Do you expect to make a profit in the future from the appreciation of assets used in the activity?

An activity is presumed to be for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training, or racing horses).

The IRS says that it looks at all facts when determining whether a hobby is for pleasure or business. The profit test is the primary test. If the activity earned income in three out of the last five years, it is for profit. If the activity does not meet the profit test, the IRS will take an individualized look at the facts of your activity using the list of questions above to determine whether it’s a business or a hobby. (It should be noted that this list is not all-inclusive.)

Business Activity: If the activity is determined to be a business, you can deduct ordinary and necessary expenses for the operation of the business on a Schedule C or C-EZ on your Form 1040 without considerations for percentage limitations. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is appropriate for your business.

Hobby: If an activity is a hobby, not for profit, losses from that activity may not be used to offset other income. You can only deduct expenses up to the amount of income earned from the hobby. These expenses, with other miscellaneous expenses, are itemized on Schedule A and must also meet the 2 percent limitation of your adjusted gross income in order to be deducted.

What Are Allowable Hobby Deductions?

If your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity.

Deductions for hobby activities are claimed as itemized deductions on Schedule A, Form 1040. These deductions must be taken in the following order and only to the extent stated in each of three categories:

• Deductions that a taxpayer may claim for certain personal expenses, such as home mortgage interest and taxes, may be taken in full.
• Deductions that don’t result in an adjustment to the basis of property, such as advertising, insurance premiums, and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.
• Deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.

If your hobby is regularly generating income, it could make tax sense for you to consider whether it’s a business or not. You may be able to save on taxes.

If you’re not sure whether your hobby is actually a business, contact me and we’ll help you figure it out.

Some Commonly Overlooked Small Business Deductions

Posted by Bruce Mc on Apr 6, 2009 in Deductions, Form 1040 Information, Opinions, Schedule C, Tax Preparation, Things forgotten | 1 comment

Written by: Courtney Phillips

In the current economic climate, it is no surprise that people are looking for ways to save on their taxes.  Over the last several years, many people have begun to telecommute, freelance, or work from home.  These people often do not realize that there are many things that can be deducted from taxes as an independent contractor.  Other small business owners may not realize what is deductible and what is not. 

Whether you do your taxes on your own or use a tax professional to help you through the filing process, look into whether or not some of the following commonly overlooked small business deductions apply to your situation.

Office Space – If you have a dedicated office space in your home, you may be able to deduct the value of the square footage.  There are some requirements that your office must meet, like being strictly used for business purposes.

Gift Deductions – Perhaps you have donated goods or services at some point throughout the last tax year.  These gifts are often tax-deductible, so keep track of donations and gifts.

Office Supplies – Office supplies that are necessary to the functionality of your office and business can be tax-deductible.  Make sure that you keep meticulous records of what you purchase for your office so that money can be accounted for later on down the road.

Communications – Office lines, dedicated cell phones, fax lines, and internet connections may all be tax-deductible, depending on your situation.  These types of services are often necessary for operating a successful business and can give you a much-needed break come tax time.

Equipment – Purchasing new office equipment and other items needed to perform the tasks related to your business are generally tax-deductible as well.  If you need to buy external hard drives, printers, or other hardware, keep track of your spending.

Professional Organizations, Memberships, and Fees – These things are all commonly overlooked tax deductions.  If you belong to a particular group, subscribe to a trade journal, or keep memberships in order to meet with and entertain clients, you may be able to deduct these expenses as well. 

Talk with a tax professional, like Bruce or visit www.irs.gov for more information regarding tax guidelines for business deductions.

This post was contributed by Courtney Phillips, who writes about how to obtain bachelors degree online (Bachelors Degree Online). She invites and welcomes your feedback at CourtneyPhillips80 at gmail.com

Be sure to check out the Carnival of Pecuniary Delights No. 1: The Madoline Hatter Pecuniary Art Edition. it is a must read for us all.