Hobby or business?

[NECPA in NEBRASKA]

I have been going round and round with a client about whether her Mary Kay is a business or hobby. She has never produced a profit in several years, but keeps trying. She says that she is trying to make money, but that no one will buy the product without discounts. She does fill out the record sheet that Mary Kay gives them, but here gross profit is less than 50%. Her husband died unexpectedly two years ago and I know that set her back, but she has a full time job and I can't justify it being called a business when the only improvement I see is that her losses are smaller. Am I being unreasonable to not want to sign a return that continues to kick off losses. She is worried that it will trigger an audit if she changes to a hobby, but I can't let that drive the decision. She doesn't pull a lot out for personal use, but gives a ton of discounts and product away to hostesses. Thanks for any comments, good or bad. I think that it has to be a hobby, but I would love to give her the benefit of the doubt.

[mrichman333]

One simple question; is she doing this to make money or have fun. I can't imagine trying to sell make-up for the sheer joy of it. Unlike for example some who paints pictures because they love to paint and money is secondary?

Whit all other things being equal, motive would be my deciding factor.

[jainen]

>>all other things being equal, motive would be my deciding factor<<

But those other things are NOT equal. They are more important, because Reg Section 1.183-2(b ) says so. If you want to drill down to one simple question, it would be whether there is a bona fide business plan, updated annually. Motive is pretty much irrelevant in terms of the law, especially compared to what she actually does.

[NECPA in NEBRASKA]

I think that her motive is to make money, but I don't think that she actually knows how to. As far as a business plan, she says it is to try to get more parties and sales. If she doesn't have anyone working under her and collect more commissions, I don't think that she has a chance.

[jainen]

>>she says it is to try to get more parties and sales<<

That may be a business GOAL, but it is not a business PLAN. Even as a goal, it totally lacks a profit motive. Stop using the misleading term "hobby" and show her what Pub 535 says about the subject. Also assure her that continuing to claim losses is more likely to attract IRS scrutiny than not continuing to claim losses.

[MsTabbyKats]

Selling Mary Kay for 3+ years without a profit....why does she do it? Sounds more like a social thing...flag waving thing. If she were my client I would tell her "no".

[SFA]

How aggressive has she been with deductions? What is her gross profit percentage of income? Perhaps she can rethink some of the business expenses and take a more conservative approach. Mary Kay sales can fluctuate from year to year--anywhere from dormant to kicking butt--depending on the life circumstances at the time. One year a business, the next a bust.

[Guest Taxed]

If she is beyond the 3 out of 5 years without profit and lacks a business plan, I say it is a hobby. If the auditor says show me your sales plan and how many sales appointments you made, what will she show?

I have a tupperware lady as a client and she does at least one party a quarter, and deposits quarterly estimated taxes. She keeps receipts of all vehicle expenses, shipping and party expenses. In her case she did go 2 years without a profit and then she made a few thousand dollars. BTW she also got a DBA registration from her town and has a EIN.

[NECPA in NEBRASKA]

Thanks for all of the comments. It has to be a hobby in order for me to sign the return. She talked to her brother and he told her the same thing that I told her, so now she agrees that I was correct.

[OldJack]

>> It has to be a hobby in order for me to sign the return<<

Well... If for no other reason I would disagree as if the client says its a "business" its her tax return! Who are we as tax preparers to say it is our tax return just because we sign?

[NECPA in NEBRASKA]

Because it is my job to know the tax laws and how to apply them. It is not my tax return, but I cannot sign something that I believe is incorrect. No engagement letter will protect me form Circular 230 or malpractice if she pulls an audit. She can always take it to someone that doesn't care if it is a business or hobby.

[OldJack]

>>It is not my tax return, but I cannot sign something that I believe is incorrect.<<

True... But only the IRS or the client can determine if it is not a business and you are not the IRS. Truth is you might believe but your client believes different and there has been no real determination. This case is what we use to call a grey area. It is your job to know the tax laws, but not necessarily your job to apply them.

[OldJack]

A real test is if she had made a large profit, without a written plan, would you have reported it as a Sch-C business or a line 21 hobby? As a matter of fact Mary Kay has a plan which is sales by holding parties. Parties are like a crap shoot in that you spend money up front and if there are no sales you lose. It takes a lot of work to organize and conduct a Mary Kay party.

[Guest Taxed]

My Aunt used to sell Amway for years and I can tell you from personal observation, those who are successful run it like a business. There is a sales/business plan, X# of parties a year and what they demonstrate at the parties, flyers around the neighborhood and giveaways. She used to attend the conference and seminars.

I think the real issue is that there are many people who will get into Marykay etc. just to use the product personally (hoping to sell some on the way) BUT their main goal is personal use. And you can tell those people apart from the real pros like my Aunt.

[NECPA in NEBRASKA]

I will ask her some more questions, but she just threw out a bunch of product that had expired after five years, so I think that she bought too much a long time ago. Her sales have never been more than a couple thousand dollars a year and she doesn't even get a 1099. We have gone through this several times and it is not getting any better. Jack, with all of the questions I have asked, I don't feel that I have a leg to stand on if I allow it to continue to be reported as a business. I ran all of her reported expenses through last night and now she even gets a small amount of EIC. I will call her again and get more details as to how often and to whom she sells the products.

[Guest Taxed]

You said this lady has a full time job now and can not devote a lot of resources to this business, so going forward it is doubtful how many sales parties etc she will do. Perhaps it is in the best interest to call it a hobby going forward.

[Lion EA]

There are nine areas the IRS looks at for hobby vs. business. One talks about what changes you make to have fewer losses, become more profitable. Go through the IRS requirements to see if you could prevail in an audit; have your client explain to you how she meets at least some of the IRS points.

[NECPA in NEBRASKA]

We went through them yesterday after I emailed her some IRS pubs and papers on hobby. She didn't have any good answers, except that she is busy and that she needs her taxes finished ASAP so that she can give them to her kids' high school to see if she can get a scholarship for next fall. She just said that she was going to have to decide in 2013 if she wanted to continue. I do think that she had good intentions in the beginning after going to all of the conventions in Texas, but she has never shown a profit, her gross profit % for 2012 is 30% with a $3,000 loss after all of the other expenses that she gave me.

[OldJack]

Maybe the problem is are all of her expenses really business expenses?

[jainen]

>>are all of her expenses really business expenses?<<

Looks to me like NONE of her expenses are business expenses because there isn't any business activity. Just a sadly dwindling social life (probably reflecting her efforts to push overpriced gunk on her friends).

[Guest Taxed]

Maybe the problem is are all of her expenses really business expenses?

Amen! Don't we know about those pesky bills (meals and entertainment, gas etc.)

[OldJack]

>>are all of her expenses really business expenses?<<

Looks to me like NONE of her expenses are business expenses because there isn't any business activity. Just a sadly dwindling social life (probably reflecting her efforts to push overpriced gunk on her friends).

Oh please!! You have no evidence that this is a "dwindling social life". NECPA said >>I will ask her some more questions, but she just threw out a bunch of product that had expired after five years, so I think that she bought too much a long time ago.<< This may indicated the main loss this year was write-off of prior inventory.

The fact that she has a full time job is not very relevant as most Mary Kay dealers fit that bill. I know of no requirement that there be a "written plan" for any business. In fact, most small businesses only write a plan if they need to borrow money. So maybe she just needs to write a plan for the tax preparer?? If that is the case just help her write a plan!!

The 3 out of 5 rule is only a safe harbor and not a requirement later to declare the business as a hobby. I have know of business' that did not meet the 3 out of 5 and certainly continued as a business without classifying themselves as a hobby.

So if she makes a hugh profit next year are you going to still claim its a hobby and not report on Sch-C???

[NECPA in NEBRASKA]

Old Jack, if she makes a profit in 2013, I will amend this year for free and apologize. I called her today and asked her what $220 of labor is and she paid her daughter to count inventory. Her inventory is $800. That seems like pretty high labor, She is fine with it being a hobby for 2012.

[BulldogTom]

I have know of business' that did not meet the 3 out of 5 and certainly continued as a business without classifying themselves as a hobby.

Uh, that would be me in my tax business. I have been working at this for 15 years. 4 profitable years, 11 loss years. First 5 were disasters, and the first year after I moved into an office outside the home was a huge loss. Don't call my business a hobby. I do however gain a certain degree of enjoyment from doing it. And I have had a full time job the entire time I have been in business.

Tom

Hollister, CA

[NECPA in NEBRASKA]

Tom, I don't think that anyone would be in this business as a hobby. Who would want all this stress for fun?