Hello and thank you for your question.
Judging by the many 'no' answers that you list, it seems likely that
your activity is more hobby than business-for-profit.
You've probably already seen this, but I'll list the IRS test:
"Activities Not Engaged in For Profit - Hobby Loss (IRC Section 183)
1. IRC section 183(a) provides that no deductions shall be allowed
in the case of an activity not engaged in for profit, other than
those otherwise allowable under the Code, and supplies some criteria
to be used in making the determination as to the profit notice. IRC
section 183(d) gives the taxpayer a rebuttable presumption that an
activity is a business and not a hobby, if profit results from the
activity in three out of five (two out of seven in the case of horse
racing, breeding or showing) consecutive years.
2. Since a full presumption period is not available when the
taxpayer first begins the activity, IRC section 183(d) allows him to
make an election which will defer the determination until he has had
the opportunity to achieve the presumption during the first five (or
seven) years of the activity.
3. Examiners should be aware that failure to make a profit does
not in and of itself indicate a lack of a profit motive. This is true
regardless of whether the taxpayer has made an election under IRC
section 183(e) or not. The question of profit motive is a factual one,
and all facts must be considered in making any determination."
http://www.irs.gov/irm/part4/ch10s18.html#d0e161598
For more on the subject, see, Avoiding the treasury stigma of a hobby
http://www.nysscpa.org/cpajournal/old/14345325.htm
But classification as a hobby is not as bad as you think. The only
important consequence is that you can't use your losses from this
activity to reduce your income from other sources (for example, to
reduce the tax on a salary from a regular job).
You should still be able to use your expenses from the hobby as an
offset to your income from that activity. In other words, you
shouldn't need to pay tax on money your earn from this activity
because you can offset those earnings by the expenses of the activity.
I say 'should' because there's a peculiar issue - - if you list your
hobby expenses on Schedule "A" they will be treated as excess itemized
deductions and because there's a 2% of adjusted gross income floor on
these kind of expenses, you could lose those deductions and still be
held to pay tax on the cash you collected from your hobby activity.
Example: Salary of 40,000, hobby income of 4,000, hobby expenses of 8,000.
Adjusted gross income 44,000
2% of AGI = 880
Hobby expense deduction
4,000 [because hobby losses can't exceed hobby income]
- 880
--------
Taxable income 44,000 - 4,000 + 880 = 40,880
So besides not being able to use any of the hobby loss to shelter
salary, you end up paying income tax on 880 of the 4,000 that you took
in.
"The problem, even if you itemize, is that employee business expenses
are "miscellaneous itemized deductions," which are deductible only to
the extent that when added to your other miscellaneous expenses (such
as tax preparation fees, hobby losses, and investment expenses) they
exceed 2% of your adjusted gross income."
http://cgi1.usatoday.com/mchat/20040402001/tscript.htm
[Actually I think you could avoid the 880 of income by listing 4,000
of the income and the 4,000 of expenses on Schedule E instead of
Schedule A but the IRS might disagree]
Most importantly, there won't be any self-employment tax for you to
pay because you're not earning any income from the activity (just
don't pay yourself any 'wages'):
"What Is Included in Net Earnings From Self-Employment?
In most cases, net earnings include your net profit from a farm or
nonfarm business."
http://www.irs.gov/instructions/i1040sse/ar02.html#d0e221
This is important, because the self-employment tax rate is 15.3%
http://www.irs.gov/businesses/small/article/0,,id=98846,00.html
So the bottom line is, your money-losing 'hobby' should add little or
nothing to your total taxes (the 'little' being the portion of your
receipts from the activity to the extent of 2% of AGI if you put your
expenses on Schedule A the way the IRS wants you to), and it won't
cost you any self-employment tax because it doesn't add to your 'net
earnings'
Search terms used:
"hobby loss" itemized example
"hobby loss" "schedule e"
"self employment tax" "schedule e" site:irs.gov
Thanks again for letting us help.
Google Answers Reasearcher
Richard-ga |
Clarification of Answer by
richard-ga
on
23 May 2005 18:48 PDT
Hello again.
Having the income on Form 1099-MISC doesn't prove it was or wasn't a
hobby. But as I said in my answer, you'll still end up with zero self
employment tax if your expenses cover the income. Here's how the IRS
explains it:
"If payment for services you provided is listed in box 7 of Form
1099-MISC, you are being treated as a self-employed worker, also
referred to as an independent contractor....
"Unless you think you were an employee, you report your nonemployee
compensation on Form 1040, Schedule C (PDF), Profit or Loss from
Business (Sole Proprietorship), or Form 1040, Schedule C-EZ (PDF), Net
Profit from Business. You also need to complete Form 1040, Schedule SE
(PDF), Self-Employment Tax, and pay self-employment tax on your net
earnings from self-employment, if you had net earnings from
self-employment of $400 or more."
http://www.irs.gov/faqs/faq4-3.html
So besides listing that income on line 1 of Schedule C, your various
expenses will be listed on lines 8 through 27.
http://www.irs.gov/pub/irs-pdf/f1040sc.pdf
If you are ready to take the position that yours is not a hobby, the
expenses will be more than the income, line 31 will be a loss, and
you'll apply that loss to other income.
If you instead are going to treat this activity as a hobby, then you
won't try to use that loss against other income (my suggestion was to
keep things simple in that case and only list enough expenses match
your income, so line 31 comes out zero).
Schedule SE is the self employment tax form, but you'll see on line 2
of that form, it starts with the number on line 31 of Schedule C, and
that's going to be zero or a loss. So your self employment tax will
come out zero.
http://www.irs.gov/pub/irs-pdf/f1040sse.pdf
-R
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