lyonsacc
Member
Everyone here at IAP has been a great help with this wonderful pen turning addiction :biggrin: thing going on in my life. So, I thought I might try to share a little of my knowledge from the work I do that helps pay for pen kits and blanks.
My wife :beauty:and I :clown:are both CPAs and have had our own little practice for about 17 years now. I deal mainly with small businesses and my wife deals mainly with individuals, but many times those things mix.
Disclaimer - This is an opinion piece:redface:; ask your tax advisor :glasses-cool:for specifics regarding your situation. Just like a CA finish, there is more than one way to do things and there are varying opinions among tax pros as to how to handle many situations. Any advice in the thread is NOT comprehensive. Commenting on this thread does not create any form of legal or client relationship. The IRS has rules, but there are exceptions and additions to the rules that would be impossible to cover in a thread like this. As well, I won't help you cheat the system
. Oh, I don't know squat about taxes in most other countries, so sorry to the great people up north, down under, and across the pond!
That being said, I want to bring up 2 or 3 questions/issues that this pen turning hobby/business can create:
1) Technically if you sell (or barter) a pen, you have to report that as income on your tax return. The problem is how or where should it be reported. (Gifts – such as those that occur during PITH are not a taxable event, but prizes won are taxable events)
2) One BIG question is if you have a HOBBY or a BUSINESS. Like most things in the US tax code, these words have definitions in the tax code that don't necessarily match what Mr. Webster would say.
3) What can you deduct? (I only touch on this a little bit here)
As a simple example. Let's say you have sold one pen for $50. You spent $15 on the pen kit and $5 on the blank. You had no other expenses during the year (just to keep things simple).
If you have a HOBBY, the $50 gets reported as income on the front page of your tax return (usually line 21 of Form 1040). The $20 of expenses get deducted on Schedule A – Itemized Deductions on line 23 – Other expense. The problem with this is that line 23 (Schedule A) is in a section in which your expenses have to exceed 2% of your Adjusted Gross Income (AGI - Line 37 Form 1040) before you can deduct anything. So, let's say you have AGI of $50,000. To get a deduction from line 23 on Schedule A the expenses have to be more than $1,000 (2% of $50,000) before you can get a deduction. If your expenses added up to $1,010 then you would get to deduct $10. :hypnotized: Oh - you only can deduct hobby expenses up to your hobby income. Treating something as a HOBBY usually stinks.
So, what does it take for something to be a BUSINESS rather than a HOBBY?
A statutory safe harbor is provided that, if met, causes a presumption that an activity is a for-profit endeavor. If the safe harbor is not met, the taxpayer must establish a profit motive using 9 subjective factors mentioned later. To meet the safe harbor, a pen making activity must generate a profit in at least three of the five years ending with the tax year in question. If the safe harbor is met, the burden of proof for lack of profit motive is shifted to the IRS
Many people say they lose money with pen turning, but I suspect that many of you could treat this as a BUSINESS for tax purposes.
Not all of your expenses are tax deductible - which can be a good thing. Let's say you make 10 pens this year. Of those 10 you keep 3, you give away 4, and you sell three. You are only able to deduct the expenses associated with the 3 pens you sold. So, you might have spent $100 ($10 each) on pen kits, but you can only deduct $30 (3 kits x $10) for tax purposes. Adding to this example, let's say that you have $50 of other expenses (CA, sand paper, bandaids:smile-big: , etc.). Then, in my opinion, it would be reasonable to also deduct 30% (3 out of 10 pens) of the $50 – which would be $15.
So, to recap, you have spent $150 ($100 on pen kits and $50 on supplies) and you have sold 3 pens (for a total of $100). On paper – and in your spouse's opinion :giggle:– you have lost money. However, in the IRS's mind you have created $55 of taxable income ($100 of sales less $30 for pen kits and $15 for supplies). That is a profit. As a "BUSINESS" your business income and business deductions all go on Schedule C. Which usually results in less tax.
If you don't meet the safe harbor rules to be a BUSINESS rather than a HOBBY (profit in 3 of 5 years), then there is a 9 part test established by regulations:
1) Do you have a profit motive, do you keep complete records, do you market/advertise?
2) Do you have expertise in this business (or retain advisors)?
3) How much time and effort is involved?
4) Is there a reasonable expectation of appreciation?
5) Has the taxpayer previously turned around an unsuccessful business?
6) Has the activity previously generated significant profit?
7) Are the profits substantial compared to the losses?
8) Is the activity meaningful to your overall income?
9) Does profit outweigh the pleasure element?
Opinions vary as to how many of these questions need to be answered positively to create a BUSINESS versus a HOBBY. Some might say just one or two of these needs to be answered yes. It really depends on the circumstances.
Now, keep in mind that if you have profit of more than $400 you have to pay a thing called the self-employment tax which depending on your circumstances and what year it is could range from 2.9% up to 15.3% of your profit.
The key parts are:
1) If you sold or bartered a pen, it is a taxable transaction in the eyes of the IRS.
2) Do you have a HOBBY (usually not a good thing for taxes), or a BUSINESS (usually a good thing for taxes)?
3) Even though you spent a BUNCH of money during the year – not all of it is necessarily a tax deduction.
Sorry for this being such a long post.
Please feel free to comment and ask questions. I'll try to answer. Please do not include personal information in your questions. Please keep your opinions about the tax code or politicians in check.
Thanks!
Dave Lyons
My wife :beauty:and I :clown:are both CPAs and have had our own little practice for about 17 years now. I deal mainly with small businesses and my wife deals mainly with individuals, but many times those things mix.
Disclaimer - This is an opinion piece:redface:; ask your tax advisor :glasses-cool:for specifics regarding your situation. Just like a CA finish, there is more than one way to do things and there are varying opinions among tax pros as to how to handle many situations. Any advice in the thread is NOT comprehensive. Commenting on this thread does not create any form of legal or client relationship. The IRS has rules, but there are exceptions and additions to the rules that would be impossible to cover in a thread like this. As well, I won't help you cheat the system
. Oh, I don't know squat about taxes in most other countries, so sorry to the great people up north, down under, and across the pond!That being said, I want to bring up 2 or 3 questions/issues that this pen turning hobby/business can create:
1) Technically if you sell (or barter) a pen, you have to report that as income on your tax return. The problem is how or where should it be reported. (Gifts – such as those that occur during PITH are not a taxable event, but prizes won are taxable events)
2) One BIG question is if you have a HOBBY or a BUSINESS. Like most things in the US tax code, these words have definitions in the tax code that don't necessarily match what Mr. Webster would say.
3) What can you deduct? (I only touch on this a little bit here)
As a simple example. Let's say you have sold one pen for $50. You spent $15 on the pen kit and $5 on the blank. You had no other expenses during the year (just to keep things simple).
If you have a HOBBY, the $50 gets reported as income on the front page of your tax return (usually line 21 of Form 1040). The $20 of expenses get deducted on Schedule A – Itemized Deductions on line 23 – Other expense. The problem with this is that line 23 (Schedule A) is in a section in which your expenses have to exceed 2% of your Adjusted Gross Income (AGI - Line 37 Form 1040) before you can deduct anything. So, let's say you have AGI of $50,000. To get a deduction from line 23 on Schedule A the expenses have to be more than $1,000 (2% of $50,000) before you can get a deduction. If your expenses added up to $1,010 then you would get to deduct $10. :hypnotized: Oh - you only can deduct hobby expenses up to your hobby income. Treating something as a HOBBY usually stinks.
So, what does it take for something to be a BUSINESS rather than a HOBBY?
A statutory safe harbor is provided that, if met, causes a presumption that an activity is a for-profit endeavor. If the safe harbor is not met, the taxpayer must establish a profit motive using 9 subjective factors mentioned later. To meet the safe harbor, a pen making activity must generate a profit in at least three of the five years ending with the tax year in question. If the safe harbor is met, the burden of proof for lack of profit motive is shifted to the IRS
Many people say they lose money with pen turning, but I suspect that many of you could treat this as a BUSINESS for tax purposes.
Not all of your expenses are tax deductible - which can be a good thing. Let's say you make 10 pens this year. Of those 10 you keep 3, you give away 4, and you sell three. You are only able to deduct the expenses associated with the 3 pens you sold. So, you might have spent $100 ($10 each) on pen kits, but you can only deduct $30 (3 kits x $10) for tax purposes. Adding to this example, let's say that you have $50 of other expenses (CA, sand paper, bandaids:smile-big: , etc.). Then, in my opinion, it would be reasonable to also deduct 30% (3 out of 10 pens) of the $50 – which would be $15.
So, to recap, you have spent $150 ($100 on pen kits and $50 on supplies) and you have sold 3 pens (for a total of $100). On paper – and in your spouse's opinion :giggle:– you have lost money. However, in the IRS's mind you have created $55 of taxable income ($100 of sales less $30 for pen kits and $15 for supplies). That is a profit. As a "BUSINESS" your business income and business deductions all go on Schedule C. Which usually results in less tax.
If you don't meet the safe harbor rules to be a BUSINESS rather than a HOBBY (profit in 3 of 5 years), then there is a 9 part test established by regulations:
1) Do you have a profit motive, do you keep complete records, do you market/advertise?
2) Do you have expertise in this business (or retain advisors)?
3) How much time and effort is involved?
4) Is there a reasonable expectation of appreciation?
5) Has the taxpayer previously turned around an unsuccessful business?
6) Has the activity previously generated significant profit?
7) Are the profits substantial compared to the losses?
8) Is the activity meaningful to your overall income?
9) Does profit outweigh the pleasure element?
Opinions vary as to how many of these questions need to be answered positively to create a BUSINESS versus a HOBBY. Some might say just one or two of these needs to be answered yes. It really depends on the circumstances.
Now, keep in mind that if you have profit of more than $400 you have to pay a thing called the self-employment tax which depending on your circumstances and what year it is could range from 2.9% up to 15.3% of your profit.
The key parts are:
1) If you sold or bartered a pen, it is a taxable transaction in the eyes of the IRS.
2) Do you have a HOBBY (usually not a good thing for taxes), or a BUSINESS (usually a good thing for taxes)?
3) Even though you spent a BUNCH of money during the year – not all of it is necessarily a tax deduction.
Sorry for this being such a long post.
Please feel free to comment and ask questions. I'll try to answer. Please do not include personal information in your questions. Please keep your opinions about the tax code or politicians in check.
Thanks!
Dave Lyons
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