Is it a Business, or is it a Hobby?

How many of you out there make really good homemade hummus? I’m typing with one hand, while I raise the other. My wife thinks that it’s better than the pre-made store bought stuff, and that I should sell it to the public. For all my clients, no, I’m not quitting my day job (yet, haha!). Aside from figuring out a catchy name for it (JayTheCPA’s hummus doesn’t quite roll off the tongue), could I really make a go of this as a business, or is it really just a hobby?

If you’ve been doing some sort of activity that you love to do (baking cakes for friends, for example), is this something that you can deduct the expenses for, and reduce your taxes? I’ll give you a big resounding maybe!

IRS has various rules to determine whether an activity is a bona fide business, or just a hobby. If an activity is an actual business, for a sole proprietor the income and expenses are shown on Schedule C, as part of your individual income tax return, and if your expenses exceed your income, the resulting loss can offset other income items on your tax return. If the activity is a hobby, expenses can only be deducted to the extent of income, so if you have no income, you can’t deduct any expenses. If you do have income, the expenses are deducted as a miscellaneous itemized deduction, subject to a floor/deductible/”haircut” of 2% of your adjusted gross income. The bottom line is that if you’ve got a hobby, you’re probably not going to get much of a tax deduction for it, if at all.

So how do you know whether your activity is a business or a hobby? Here are a few of IRS’s factors for determining the answer:

1-how is the activity carried on – IRS will look at whether the activity is being conducted in a businesslike manner. Is there a separate bank account? Are books and records being kept?

2-what is the individual’s expertise – there should be extensive knowledge of the activity, potentially showing that advice has been sought from experts.

3-time and effort on the activity – if you have a full time job and pursue the activity an hour a week, it may indicate that this is not a serious business activity for you.

4-history of income or losses from the activity – while you may be able to get away with showing a loss on Schedule C for a year or two, showing losses year after year would indicate that there’s no real profit motive for the activity, in which case IRS will deem the activity a hobby, and disallow previous losses claimed.

IRS looks at a number of other factors when making a determination of whether an activity is a business or a hobby. At this point, my hummus making (and other culinary adventures) is strictly a hobby, so I’ll keep IRS out of what’s left of my hair, and will leave the expenses off my tax return. Before you start taking deductions for your hobby, contact your friendly neighborhood CPA for advice. Do you have any interesting tax stories regarding hobbies? Please share.

Gambling and Taxes

If you like to gamble, then I have a wager for you. I’ll bet that you can learn something new about gambling and taxes from this article!

Whether you’re into rolling the dice, horse racing, cards, slot machines, or even betting on the Super Bowl or playing bingo, did you know that your gambling winnings are fully taxable and must be reported on your tax return? Did I win the bet yet?

Here’s some information about gambling and taxes:

1-Gambling income isn’t just limited to casinos or horse racing, but also includes lottery winnings, raffles, and even the fair market value of prizes, such as cars and trips.

2-The payer (casino, race track, etc) is required to give you a Form W-2G (Certain Gambling Winnings) if you receive $1,200 or more in winnings from bingo or slot machines, more than $5,000 from a poker tournament, or $600 or more in other gambling winnings (and the payout is at least 300 times the amount of the wager). There are other instances where Form W-2G is required, but I’ve covered the more common ones.

3-Generally you will report your gambling winnings on the “other income” line of your tax return (Form 1040).

4-You can claim your gambling losses to the extent of your winnings, as an itemized deduction on Schedule A, under “other miscellaneous deductions”. Note that this type of deduction is not subject to the 2% adjusted gross income limitation that’s applicable to items such as tax preparation fees, safe deposit box fees, and unreimbursed employee expenses. While you may have gambling losses, you’re not allowed to net them against the income; you must report the income as I indicated in #3, and report the losses as I just described.

5-You must keep accurate records to substantiate any gambling losses. These records can include receipts, tickets, statements, a diary, and any other documentation you have. As with any tax deduction, if you’re audited and don’t have adequate substantiation, the deduction will be disallowed.

I hope you found this information useful, whether I won the bet or not. Please forward this along to any of your gambling buddies, and happy (but responsible) gambling!

Spring Cleaning, a Little Late

It’s hot as hell outside, and you just want to hibernate in the air conditioning. Trying to figure out what to do while you’re chilling out? How about organizing your tax records?! If you start organizing yourself now, come this tax season, you’ll be cool as a cucumber, and ready to make your favorite CPA’s day, with all of your organized records. IRS has some recordkeeping tips for individuals and small business owners.

What to Keep – Individuals

IRS recommends keeping records that support items on your tax return for at least three years after the return has been filed. Some of these records are bills, credit card and other receipts, invoices, auto mileage logs, canceled or imaged checks, and any other records to support deductions or credits claimed on a tax return. You should also keep records relating to property at least three years after you’ve sold or otherwise disposed of the property. Examples of this include a home purchase or improvement, stocks and other investments, IRA transactions, and rental property records.

What to Keep – Small Businesses

Similar to individuals, for small businesses, IRS recommends the three year timeframe for retention of business records. Examples of these include records that document gross receipts, proofs of purchases, expenses, and assets. These can include cash register tapes, bank deposit slips, purchase and sales invoices, credit card charges, Forms 1099-MISC, canceled or imaged checks, account statements, petty cash slips, and real estate closing statements. Electronic records can include databases, saved files, emails, faxes, and others.

IRS generally doesn’t require records to be kept in any special manner, but common sense would indicate that having a designated place to keep your tax records is a good idea. If you have all of your records in one place, it will make your job a lot easier when preparing to meet with your CPA, or if you should be one of the unfortunate souls who receives an IRS notice, or need to substantiate something for an audit.

The morale of the story is, even when it’s brutally hot and humid outside, you can be one of the coolest people around, when you have your tax records in order (at least this CPA will think you’re cool!). How organized are your tax records? Leave a comment, telling us the good, bad, and the ugly! Please forward this article along to anybody who you think needs to get their tax @#$% together.

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