IRS Summertime Tax Tip 2008-12
Fishing, Gardening, Golf, Sewing, Woodworking, Horsemanship, Scrap Booking, Stamp and Coin Collecting. Millions of Americans participate in activities for pleasure that can also result in a profit.
The IRS isn’t trying to spoil your fun but if your favorite activity makes a profit every year or so, there may be tax implications that surprise you. For one thing, you must report and pay tax on income from almost all sources, including hobbies.
What is a hobby? Hobbies, also called not-for-profit activities, are those activities that are not pursued for profit. What is a business? Generally, your activity is considered a business if it is carried on with the reasonable expectation of earning a profit.
If you are not sure whether you are running a business or simply enjoying a hobby, here are some of the factors you should consider:
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Does the time and effort put into the activity indicate an intention to make a profit?
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Do you depend on income from the activity?
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If there are losses, are they due to circumstances beyond your control or did they occur in he start-up phase of the business?
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Have you changed methods of operation to improve profitability.
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Do you have the knowledge needed to carry on the activity as a successful business?
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Have you made a profit in similar activities in the past?
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Does the activity make a profit in some years?
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Do you expect to make a profit in the future from the appreciation of assets used in the activity?
An activity is presumed carried on 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 your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity.
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:
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Deductions that a taxpayer may claim for certain personal expenses, such as home mortgage interest and taxes, may be taken in full.
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Deductions that don’t result in an adjustment to the basis of property, 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.
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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.
If you are conducting a trade or business you may deduct your ordinary and necessary expenses. An ordinary expense is an expense that is common and accepted in your trade or business. A necessary expense is one that is appropriate for your business.
More information is available on the IRS Web site at IRS.gov. A good resource is Publication 535, Business Expenses, found on the web site or by calling 800-TAX-FORM (800-829-3676).
Remember that for the genuine IRS Web site be sure to use .gov. Don't be confused by internet sites that end in .com, .net, .org or other designations instead of .gov. The address of the official IRS governmental Web site is www.irs.gov
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