Hobby status on taxes

[Deleted]

I have a photography business set up as an S-corp that I've run for a year. I've decided to shut down and maybe reopen years from now. I think I may keep shooting for friends and family and they will probably insist on paying me.

What are the advantages/disadvantages of hobby status?

[mwcpa]

a hobby, from a tax standpoint, will require that you report "income" on line 21 (other income) and can claim expenses up to the amount of income as a itemized deduction, subject to a 2% AGI limit.

Sales tax will be an issue.....

[Deleted]

Luckily I live in a non-sales tax state. I was just thinking that hobby status may allow me to deduct the cost of insurance from my sales, and allow me to still have some sales, rather than shutting down completely. It would be nice to take a few clients a year and earn under 2k.

[mwcpa]

if the operation is a hobby you cannot just offset the income and expenses....

the insurance costs would be an itemized deduciton subject to the 2% AGI limits....

[rangerj]

Added notes:
Income from whatever source derived is reportable for tax purposes, unless specifically exempt by laws written by Congress. Therefor "Hobby Income" is reportable. Note that the title of the Internal Revenue Code section regarding hobby LOSSES was changed from "Hobby Loss" to Losses from "Activities Engaged In For Reasons Other Than Profit" at about 1975. See section 183. This is from memory and may not be exact. The idea is to not allow personal losses to offset income. The other distinction is that deductions for ordinary and necessary BUSINESS deductions per section 162, that is expenses related to an active trade or business, are DIRECTLY deducted from business income, and losses are generally allowed to offset other income. Expenses of a hobby are deducted as itemized deductions, per section 212, as they are not incurred in an active trade or business. There is "pecking order" for the hobby expenses, that is the order in which the expenses are deducted against income. Some expenses are fully deductible (generally), e.g. taxes, interest, and casualty losses. See a TAX PROFESSIONAL FOR THE FIRST YEAR (AT LEAST).

[Deleted]

How do you determine the difference between a hobby and business?

[TheOtherMe]

It's all about intent. Do you intend to make a profit? There are lots of court cases on this topic.

And I've audited quite a few--lost some, won some.

[mwcpa]

As is noted, do you intend to make a profit.... Do you operate in a business like fashion.... How much effort do you put into the endeavor...... What training do you have..... And so on.....

There is not one thing that determines if an endeavor is a for profit venture or a hobby.....

[rangerj]

How many years would a prudent businessman operate a business that loses money every year? Do you have another source of income supporting the so-called business? Is the "intent" to make a profit realistic, given the way you operate the business, e.g. time spent, efforts made, education, advertising, etc. Do you operate your business in the same way that others who are successful in the same business do. My point is that "INTENT" is determined by a myriad of facts and circumstances that are specific to the case at hand. As a historic note the reason Congress changed the title of the code section from HOBBY LOSS, to LOSSES from an activity engaged in for reasons other than profit motive (Paraphrased), is that some wealthy race horse owners objected to the tax code calling their expensive entertainment a HOBBY. And that is straight from the horses mouth, or was it the other end of the horse?

[Deleted]

I thought that if you had losses for X amount of years when you were starting, the IRS claimed it is a hobby, no matter how hard you work or what other evidence you had of intent. I did not know the X, but that was what I was told.

[mwcpa]

gin....

there is no rule about how many consecutive years one can have a "loss"... but there is a presumption that if you have a profit in 3 out of 5 years (horses are different) that you have an intent to make a profit.....

[Deleted]

Dec 13, 2012 12:42:32 GMT -5 mwcpa said:

gin....

there is no rule about how many consecutive years one can have a "loss"... but there is a presumption that if you have a profit in 3 out of 5 years (horses are different) that you have an intent to make a profit.....

Thanks!

[rangerj]

The presumption, 3 out of 5, or 2 out of 7 for horsing around, is a rebuttable presumption. Anytime I handle one of these I require the client to make the necessary "disclosure" of the tax position in order to avoid possible penalties if the loss is disallowed at a later date. Also note that the government can ask for a consent to extend the statute of limitations until the 5 years or 7 years lapses so they can disallow all losses taken back to the beginning of the so called business. Keep in mind the government does not disallow a profit. It is the losses that they object to.

[Deleted]

Dec 13, 2012 14:24:00 GMT -5 rangerj said:

The presumption, 3 out of 5, or 2 out of 7 for horsing around, is a rebuttable presumption. Anytime I handle one of these I require the client to make the necessary "disclosure" of the tax position in order to avoid possible penalties if the loss is disallowed at a later date. Also note that the government can ask for a consent to extend the statute of limitations until the 5 years or 7 years lapses so they can disallow all losses taken back to the beginning of the so called business. Keep in mind the government does not disallow a profit. It is the losses that they object to.

Explain this please?

[mwcpa]

there have been a lot of posts related to hobbies over the last few months...

www.irs.gov/uac/Is-Your-Hobby-a-For-Profit-Endeavor%3F

"Explain this please? "
www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/IRC-%C2%A7-183:--Activities-Not-Engaged-in-For-Profit-(ATG)

"Under IRC § 183(e), a taxpayer may elect to postpone a determination of whether the presumption applies until the close of the fourth taxable year (or the sixth year for qualifying horse activities) following the first taxable year in which the taxpayer engages in the activity. An electing taxpayer may file returns in the interim on the assumption that the activity is conducted for profit"

in regards to the infamous and often misunderstood 3/5 2/7....emphasis added... (this is from the IRS audit giude linked above)
"If the taxpayer meets the presumption rule, the Service can still argue that the activity is not engaged in for profit; however, the burden of proving that the activity is not engaged in for profit shifts to the Service. In addition, examiners cannot use IRC § 183(d) as the sole basis for disallowing losses under IRC § 183 even if it is shown that the taxpayer has not met the presumption rule."

[rangerj]

The tax code provides for the disclosure of a controversial tax position in the tax return. The disclosure should include an explanation of the "reasonable basis" for taking the position, e.g. a tax case, Revenue Ruling, Private Letter Ruling, regulation, etc. As Long as the reasoning is not frivolous then penalties should not be applied in the event that the government disallows the loss deduction because the "business" is really a "hobby".

[TheOtherMe]

I still prepare one person's tax return. It has a hobby on it. Most years it has a loss. This year it will be showing a profit. The person says it's just something they do in their spare time and it is not a business. It was being reported as a hobby when I took over the preparation.

[mwcpa]

As with many things in the tax law, the answer is not always 100% clear and it comes down to facts and circumstances... while many things are clearly hobbies and others are clearly businesses, the ones in between, the "gray area" operations, are ones that require an analysis of the rules. As noted by ranger, when in doubt, make the disclosure.... but, actual "profit" is one of many factors in the decision making process....