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Hobby Rules - Don't Even Ask


Edsel

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The following discussion is based on my understanding of the new tax law, and therefore subject to correction.

The IRS treatment of "hobby losses" has never been fair, but with the new law, it is bound to be even worse.  If you take the trouble to report correctly, you must claim the Revenue as fully taxable on line 21, but cannot deduct the expenses except under limited arrangements.  The expenses are first limited to revenue reported on line 21, then are ushered onto the 2% itemized deduction category.  This means if your miscellaneous deductions do not exceed 2%, you can't take ANY expenses.  In addition to exceeding the 2%, you must then itemized deductions.  If you are limited to the standard deduction, you can't take any expenses either.

As if this wasn't bad enough, the new law apparently is doing away with the 2% category entirely.  So now we must report revenue from hobbies on line 21, and that's the end of it.

From my narrow-minded moral perspective, it suffices that the intent of tax law should be simply to disallow losses from hobbies.  It is a distorted and confiscatory intent to try to make "income" out of hobby losses.

Part of my interviewing process is to determine whether there is unreported income and to stop taxpayers from taking losses on activities that are obviously not-for-profit and have no hope of ever making a profit.  From my perspective if I see evidence of hobby activities it is fair for me to simply not even ask.

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 With the total loss of 2% Miscellaneous itemized deductions, where are 1041 beneficiaries in final year going to deduct their respective carryover losses from the K-1, or people with 100% distributions of ROTH-IRA with losses going to deduct the losses? This doesn't effect only your hobby loss expenses..

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More casualties of the 2% category:

People with extremely high work-related expenses.  It is now better for most of these people to create a proprietorship, and deduct ALL ordinary and necessary expenses.  There are some proprietorships which cannot be supported (only one customer, no control over workplace decisions, etc.) but whether or not they can meet the litmus test, there's no question that the math works out better for them.

Expect a rash of suddenly-formed consulting proprietorships and LLCs in the next 2-3 years.  And then expect the IRS to react by mass employee reclassifications like they did in the late 1990s.

I was fortunate to leave the corporate workforce in 2006, with enough large customers to justify a proprietorship.  Even better than the tax savings was the end of having to work in the corporate environment.  People are very sick of working for managements that require the selling of their souls.  Pressure to bail out management for their own screw-ups, pressure to work overtime with a smile for nothing, pressure to hide information embarrassing to your superiors yet but of their own making.  And for a job well done, the rewards go to someone else.  During my corporate career, I have worked for employers with only a handful of people, and for Fortune 500 companies with workforces of thousands.  If you can work for yourself, be your own person, and handle the unique challenges that come with it, your persona will be richly rewarded.

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20 hours ago, Edsel said:

People with extremely high work-related expenses.  It is now better for most of these people to create a proprietorship

Not really. If AMT applies, they weren't deducting the 2% items anyway.

Plus you can't arbitrarily go to your employer and tell them you want to be a 1099 contractor. And do you really want to give up health insurance, unemployment insurance, 401k match, etc. plus pay the employers half of Social Security and Medicare?

Tax rate decreases and increased credits offset the loss of these deductions in most cases, so at least in that sense, it was a simplification. Besides, there were a lot of made up expenses in the 2% category.

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Abnormal, thanks for taking the time to respond.  Your response would not normally need the scrutiny I'm going to give to it but there are broad myths and misconceptions about employee status.

If AMT applies, they weren't deducting the 2% items anyway.  The statement is true, but AMT does not always apply, and under the new law doesn't quite have the same punch that it did prior to 2018.  Part of the reason it loses its punch is because of the eradication of the 2%

Plus you can't arbitrarily go to your employer and tell them you want to be a 1099 contractor.  You'd be surprised how many of today's employers will gladly rid themselves of employees as long as they get the work done.  They not only rid themselves of 40 hours cost plus fringes, but many managements are under pressure to cut labor costs at every opportunity.  I do a great deal of work for two former employers whose departure was amicable.  The difference is they know they can no longer order me around like I have no alternatives other than putting up with them.

And do you really want to give up health insuranceNo.  This is the strongest factor you present.  It is virtually impossible to find health insurance as cheap as that which the employer can provide.  That assumes that the employer is not trying to bail out of providing insurance to begin with, as thousands have done so.

Unemployment insurance.  Yes.  The is the weakest factor you present because you are not employed under either scenario.  Consulting income virtually eclipses unemployment benefits.  I can't give credence to sitting around collecting unemployment or working under the table.

401k matchThe key word is "match", and that is a true benefit, and another strong factor.  However custodial fees are so high with a 401k that I have seen many of my clients convert large balances to an IRA and then re-enroll in the employers 401k.

employers half of Social Security and Medicare?  The consultant has to pay both ends of SS/Med, but does so only on the net income after allowable expenses.  Allowable expenses for an employee are no longer deductible for anything, but with a consultant they are deductible "above the line."  Given sufficient expenses, a taxpayer's net income tax plus self-employment tax is less than would be the case under an employment arrangement.

Tax rate decreases and increased credits offset the loss of these deductions in most cases, so at least in that sense, it was a simplification.

Besides, there were a lot of made up expenses in the 2% category.  I hope as a preparer, I am diligent enough to stop excessive made-up expenses.  I have to depend on the taxpayer, but my best estimate is they lost more as a result of the 2% than they were gaining by misrepresentation.

Abby Normal - I have been following your many posts for my duration here.  I have a great appreciation for your tax knowledge, and the fact that you can even forge a dialogue such as you have above is to your credit as a great analytical thinker.

Best regards, "Edsel"

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