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1099NEC Hobby


JackieCPA

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Hello! 

Client is selling nails or makeup and it was reported on Form 1099NEC. However, she made it clear that it is a hobby as she pays more for the products than she sells them for and sells to family and friends mostly to get discounts on her products for herself. 

On the instructions for 1099NEC it says "If you are not an employee but the amount in this box is not self-employment (SE) income (hobby), report this amount on the "Other Income" line (on Schedule 1). 

I get that, makes sense, easy. However, I had a client a few years back with the same scenario and he received a letter because they wanted the self-employment tax on it since it was put as Nonemployee Compensation. 

So my thinking is to put the amount on the schedule C, but the same amount as the deduction, netting it to zero. Then putting the amount on Schedule 1 as Other Income. I might be thinking too much into this, but it's only February 11 and my brain is tax fried already. :) :) :)

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1 hour ago, Possi said:

If she worked for the money, it ain't a hobby in the eyes of the IRS. If she LOSES money 3 out of 5 years, the IRS can look back and deem it a hobby. But, they will want the SE tax.

Not quite that simple:

https://www.irs.gov/newsroom/business-or-hobby-answer-has-implications-for-deductions

And, hobbies can deduct cost of goods sold against hobby income, up to the amount of income, right on the Other Income line.

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8 minutes ago, Abby Normal said:

Not quite that simple:

https://www.irs.gov/newsroom/business-or-hobby-answer-has-implications-for-deductions

And, hobbies can deduct cost of goods sold against hobby income, up to the amount of income, right on the Other Income line.

Hobby expenses must be deducted on the Sch A. That is what I always thought, and it's in that link you sent:

Deductions for hobby activities are claimed as itemized deductions on Schedule A (Form 1040). These deductions must be taken in the following order and only to the extent stated in each of three categories:

Deductions that a taxpayer may take for personal as well as business activities, such as home mortgage interest and taxes, may be taken in full.

Deductions that don’t result in an adjustment to basis, such as advertising, insurance premiums and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.

Business deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.

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Facts and circumstances.  There are a lot of people who sell this stuff to get their own supplies at the discounted "wholesale" price.  Then they sell some to friends and family, and once they take expenses into account, it's a loss for the year.  There are a lot of people who go into it with a profit motive and take a few years to learn why everyone decries MLM schemes, and then give up as having had an expensive lesson.

If she treats it as a hobby, then yes Sch C, back it out, then put the income on "the line formerly known as Line 21."  Then she pays ordinary income tax on hobby income, because the expenses indeed go on Sch A except they don't usually have any effect with the new, higher, standard deduction.

If she thinks it's a business that will at some point earn her a profit, then put it on Sch C and take the expenses and losses - and be prepared to demonstrate profit motive if the losses continue.  I have one business client that has losses every year, and has been audited for that.  I successfully defended the position - the statute says there must be a profit motive, and actions taken towards becoming profitable.  The statute does not state the person needs to be competent!  My client has a definite profit motive, and is merely incompetent at running a business.  The agent I dealt with accepted my proofs, and accepted the "incompetence" defense with a bit of chagrin - but he accepted it.  The years have borne it out; every year his overall losses are lower and I expected that 2020 would (finally!) show a profit, before the world went mad.

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1 hour ago, Possi said:

Hobby expenses must be deducted on the Sch A. That is what I always thought, and it's in that link you sent:

Deductions for hobby activities are claimed as itemized deductions on Schedule A (Form 1040). These deductions must be taken in the following order and only to the extent stated in each of three categories:

Deductions that a taxpayer may take for personal as well as business activities, such as home mortgage interest and taxes, may be taken in full.

Deductions that don’t result in an adjustment to basis, such as advertising, insurance premiums and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.

Business deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.

@PossiI think what Abby is saying is correct.  For a hobby that is selling an item, the "Gross Sales Price Less the Cost of Goods Sold" is taxable.   This goes back to the basic premise of tax law that only the accession to wealth is taxed.   The expenses not related to the Gross Income follow the rules you posted above.   

This 2019 article from a CPA firm says it better than I can.  "If you sell goods as part of your hobby, cost-of-goods-sold is deductible, subject to the gross income limitation.  The TCJA suspended miscellaneous itemized deductions until 2026, removing the ability to deduct hobby activity expenses, other than cost of goods sold." 

To get to the proper reporting of the taxable income, and to reflect the full amount of the 1099NEC on the return, you would follow the procedure Abby outlined above, putting the full amount of the 1099NEC on the other income line and then backing out the COGS on the same line.

Tom
Modesto, CA

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