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Avoid the Wrong IRS Determination

Author: Keith Huggett

In today's economy, many people are finding it difficult to survive with only one source of income. The business minded people often choose to start a business from something they love to do - putting a hobby to good use.  If this happens to be a choice you would like to explore, there are a few regulations you should know about.

What is a hobby business?

A hobby business is usually operated from home. Jewelry making, refinishing antiques, even quilting can be, and usually are, a hobby business.  Almost any hobby can be transformed into a "hobby business."

Proving that your hobby is a business...

Having a side (hobby) business allows you to deduct losses from this business activity on your tax return. The issue here is that these deductions can only be made for a bona fide business. If the IRS decides that your business is actually a hobby, you wll lose the ability to claim these deductions.

So how do your prove to the IRS that you are actually running a business? It's simple, at least on paper.  Your business must be out to gain a profit.  The IRS uses several different criteria for deciding if your business is operating to gain a profit.  The one they use the most is called a "3 out of 5" test.  If your business made a profit in any three of the last five years, you are obviously working to gain a profit.

There are additional ways to prove your business is not just a hobby.  Having professional business cards and stationery, well maintained books, and separate bank accounts are only a few.  It is also helpful, and usually required, that you have a business license from your city.

Running a business is a very time consuming, high energy, work in progress.  As a business owner you will find yourself wearing many different hats.  Our specialists at The Tax Office, Inc., have received training to assist business owners like you to help you grow your business.  Should you have any questions regarding determining if your business is a hobby, please contact us for a free, no obligation consultation.

Does the IRS Get a Share?

Author: Jenny Shilling

"Bees’ll buzz. Kids’ll blow dandelion fuzz. And I’ll be getting the yard sale set up. In summer..."  Thanks Olaf. Instead of lazing about with a drink in hand, I'll be hauling out all of the things that have collected in the garage/barn over the years, making advertisement signs, and deciding on prices, for a long weekend of sales. Just like thousands of other families across America. Yard sales can be simply a way to clear out your garage, a hobby, or a business for some people. 

Now, when you look at a yard sale, the merchandise that you are selling for the most part are items that you own for personal use: furniture, clothing, kitchen goods, music, books, etc.  When you sell these they are generally taxable as capital gains. Capital gain is the difference between the selling price and the basis (usually, the purchase price). If you do hit the yard sale jackpot and make money on the sale of your personal items or items held for investment (like a coin collection or collector’s item), you would report the gain on your federal form 1040 at Schedule D.

Now going back to the garage sale statistics. The overall average price of goods sold at a yard sales is $0.85.  Not quite the gain you were hoping for. But does that qualify as a loss? Not for federal income tax purposes.  If you try having a virtual yard sale online, the same rules apply: if you have a gain, you report it and if you have a loss, you end up with what someone is willing to pay.

Things can be a little more complex when you make yard sales more than an occasional occurence or hobby.  You can become a yard sale hobbyist if you engage in activities for fun, and not for profit. That doesn’t mean that you can’t make money, because you can,  but the IRS wants to know that profit isn’t your primary motive. 

If your sales happen more and more often, the IRS may determine that you’re running a business. This can be true even if you don’t feel like you’re running a business and even if you don’t make any money. If your activities rise to the level of a business, you would report your sales and expenses on your federal form 1040 on a Schedule C. The plus side of filing the Schedule C? If you qualify as a business and you lose money on your venture, you can claim the loss.

When it gets to that point - you've entered the world of Storage Wars, and we don't want to go there. It's much safer to simply empty your own storage facilities, make a little money on the side, and have the rest of the summer to enjoy. And rest assured, your children will soon outgrow another set of clothes in another month and you storage will replenish itself. And now you have time to browse other people's  yard sales.

Should you have any questions regarding taxes, capital gains, or if your yard sales fall into the hobby or business category, please contact the specialists at The Tax Office, Inc. Helping grow your business, hobby, or special interest is our speciality.

How You Can Avoid the IRS Hobby Determination

Author: Keith Huggett

When you are a successful business owner, the IRS is fully aware of it.  Being a successful business owner and starting a second business that does not perform as well as it should, tends to throw a red flag at the IRS, indicating that the second business is more of a hobby than a business. To be a "business" your goal must be to have a profit. If, year after year, you claim a loss in your second business, the IRS may take a closer look. Here are some tips for avoiding the Hobby classification:

1. Model your "hobby" after your primary business. If this isn't feasible, document why, and come up with a different strategy.
2. Create a new business entity for your "hobby" along with new business bank accounts.
3. Keep a log of the time and effort you spend working on the business aspects of your "hobby."
4. Have a written business plan.

While these tips may not always be enough to avoid the classification of a  "hobby" having good records may save you from tax penalties.  As always, if you are being contacted by the IRS, we suggest that you seek assistance from a professional tax preparer.

At the Tax Office, Inc., our Tax Professionals are available to answer any questions you may have on taxes, hobby businesses, business entities, or IRS audits. Please contact us with your questions.