Hobby or business?

[OldJack]

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

You are a fine example Tom! Where was your written plan??? Sounds like you are a "sadly dwindling social life". LOL

[OldJack]

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.

If I were an IRS auditor I would find that once a hobby always a hobby unless you can proof something unusual has changed (other than profit).

[Jack from Ohio]

These are the points that would have to be supported in an audit situation. You do not need to have positive answers to ALL to be considered a business, but you would need a majority of them to be positive answers to support your activities as a business...

From the IRS...

Is your hobby really an activity engaged in for profit?

In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business or for the production of income. Trade or business activities and activities engaged in for the production of income are activities engaged in for profit.

The following factors, although not all inclusive, may help you to determine whether your activity is an activity engaged in for profit or a hobby:

• Does the time and effort put into the activity indicate an intention to make a profit?
• Do you depend on income from the activity?
• If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
• Have you changed methods of operation to improve profitability?
• Do you have the knowledge needed to carry on the activity as a successful business?
• Have you made a profit in similar activities in the past?
• Does the activity make a profit in some years?
• Do you expect to make a profit in the future from the appreciation of assets used in the activity?

An activity is presumed for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses).

If an activity is not for profit, losses from that activity may not be used to offset other income. An activity produces a loss when related expenses exceed income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.

[OldJack]

>>The following factors, although not all inclusive, may help you to determine whether your activity is an activity engaged in for profit or a hobby:<<

It does not say if any of those things would make it a hobby nor does it say that the tax preparer should make that determination.

[NECPA in NEBRASKA]

Jack, I went through those questions with her. All of the answers were negative.I do not want a preparer penalty for taking a stance that it is really a business when she has no intention of trying to make money. She admits that she spends very little time on it. I have to make the determination of whether I want to sign the return or not. If she wants it to be a business for 2012, she can take it to someone else that doesn't care.

[OldJack]

I never meant to indicate that it was not your call NECPA. Of course you are the preparer and must be the one to sign or reject the tax return. Just make sure that you are not being overly influenced by a possible penalty. You are not an IRS employee yet, although we probably will be soon. Good luck.

[NECPA in NEBRASKA]

Thanks. She just came in and said that she may be starting Team National this year and that she didn't do parties anymore for Mary Kay. She sold to family and close friends and used the product herself. I know that I don't work for the IRS yet, but they are sure pushing for it. I am just super cautious. I am the sole support for my family now and I don't want anything to screw it up for a few hundred $ in fees. I belong to another list serve with a couple of CPA's on there that scare me to death daily with their horror stories about Circular 230 audits.

[OldJack]

The money is in business (corp) clients and I have always tried to get out of the average 1040 tax business. It makes tax season shorter and much less hassle.

[Guest Taxed]

Thanks. She just came in and said that she may be starting Team National this year and that she didn't do parties anymore for Mary Kay. She sold to family and close friends and used the product herself. I know that I don't work for the IRS yet, but they are sure pushing for it. I am just super cautious. I am the sole support for my family now and I don't want anything to screw it up for a few hundred $ in fees. I belong to another list serve with a couple of CPA's on there that scare me to death daily with their horror stories about Circular 230 audits.

Can we all agree that selling to friends and family and using the product herself is going to raise serious questions at an audit.

[OldJack]

Can we all agree that selling to friends and family and using the product herself is going to raise serious questions at an audit.

Well that is the most common customers of products like Mary Kay. It might be a problem if she was selling below cost or creating a loss with the related party transaction, otherwise I see no problem. As to selling to herself, that is treated as a withdrawal of inventory at cost, creating no profit or loss, and is irrelevant if this is not a corp entity. Therefore I would not agree and would remind an auditor that he would look foolish on appeal.

[BulldogTom]

You are a fine example Tom! Where was your written plan??? Sounds like you are a "sadly dwindling social life". LOL

Yes, I do have a business plan, but it is in a spreadsheet and goes back to the first year of business. So do all of my mileage logs.

Sadly, I do have a swindling social life - oops, I meant dwindling.

Tom

Hollister, CA

[MAMalody]

<<<efforts to push overpriced gunk>>>

Obviously, a male perspective!

[SFA]

Years ago I went to audit on a hobby vs business challenge. He lost some miles, but that was about it. Next several years, more losses. Finally he sold for a large profit. You may be thinking that the buyer didn't know about his losses. Not true. The buyer was well informed.

The auditor was skeptical, but never treated him as if he was cheating or filing fraudulent returns. We presented our case, she reluctantly agreed to not recharacterize.

We also have had clients where initial enthusiasm and expectations are high, but the activity quickly fizzles into minimal sales and feeble effort. Most of these clients know when they have crossed the line into hobbyland. We keep notes in our files if we have concerns and the dates of our discussions with them about their losses.

[Guest Taxed]

What kind of evidence did you present to IRS to convince that it was a business and not hobby? Does the IRS have an audit manual for this? I know they have field audit manuals for various business returns?

[SFA]

We presented their record keeping system; answered her questions about ongoing changes made to improve prospects for profit; showed promotional materials and information about the nature of the business--it's market and his standing within the market.

My client had a full time job and was using the money to finance his business. He and his wife were serious and not intimidated by her questions. They believed in their businesss and were proud of it.

The auditor believed there was a social aspect that weighed in favor of a hobby decision. It was true, but who shouldn't love what they do, especially if surrounded by others doing the same thing?

That was our experience. Every situation is unique.

[bertrans]

>>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.

Your comment is absolutely correct: if she continues filing Schedule C's with a loss, year after year, she will be increasing her chances of having all returns with an open assessment statute examined as a section 183 audit.