Cliff Beacham CPA | email cliffbeacham@cpa.com | California |  Tel: (949) 813-1349 
Cliff Beacham Tax and Business Consulting Certified Public Accountants
Hobby income
Some hobbies generate income; some may eventually develop into a business The IRS treats hobbies differently from a trade or business. The crux of the matter is that the IRS does not want a taxpayer to be able to write off hobby expenses by calling them trade or businesses expenses So, the first question is whether the activity is a hobby or a trade or business The tax law does not define a “trade or business” but for it to be a trade or business, an activity must have a profit motive and some kind of economic activity So what defines a profit motive –  The IRS uses a list of things to consider whether an activity is for profit      - all of which must be considered together: What is the possibility of profit? Does the taxpayer depend on the activity as a source of income? Is the activity carried out in a businesslike manner? How much time and effort does the taxpayer spend on the activity? Are losses from the activity the result of sources beyond the taxpayer’s control? Has the taxpayer changed business methods in attempts to improve profitability? What is the taxpayer’s expertise in the field? What success has the taxpayer had in similar operations? Will there be a possibility of profit from asset appreciation? Presumption of profit motive: If an activity shows a profit for any 3 or more years during a period of 5 consecutive years then the IRS will presume that a taxpayer has a profit motive Note:  if the activity involves breeding, training, showing or racing horses, the period is 2 out of 7 years Of course, any activity that is reported on a tax return as a business but has had year after year of losses and no gains will probably eventually come under scrutiny by the IRS Tax Treatment of Hobbies - if an activity is deemed to be a hobby, then “hobby loss” rules – apply. Under these rules, any income from the hobby is reported on the face of the tax return, and the expenses are only deductible if a taxpayer itemizes their deductions on Schedule A. In addition, hobby expenses are limited by category as follows: Category 1:  In this category expenses are reported on the appropriate lines of Schedule A as they would be if no hobby activity existed and includes deductions for home mortgage interest, taxes, and casualty losses Category 2:  Most expenses that a business would incur, such as those for advertising, insurance premiums, interest, utilities, wages, etc., belong in this category. They don’t result in an adjustment to the basis of property but only to the extent that gross income from the activity is greater than the deductions under Cat 1 Category 3:  Depreciation and amortization belong in this last category. These deductions are allowed, but only to the extent that the gross income from the activity exceeds the deductions under categories 1 & 2 above. In other words category 3 is not intended to create a loss as a net result Note:  Taxpayers have to claim the amounts in categories (2) and (3) (as miscellaneous deductions on Schedule A) which are subject to the 2% AGI reduction; as a result, they are not deductible for AMT 2.   Call Cliff at (949) 813-1349
Cliff Beacham CPA | email cliffbeacham@cpa.com | California | Tel: (949) 813-1349
Cliff Beacham Tax and Business Consulting Certified Public Accountants
Hobby income
Some hobbies generate income; some may eventually develop into a business The IRS treats hobbies differently from a trade or business. The crux of the matter is that the IRS does not want a taxpayer to be able to write off hobby expenses by calling them trade or businesses expenses So, the first question is whether the activity is a hobby or a trade or business The tax law does not define a “trade or business” but for it to be a trade or business, an activity must have a profit motive and some kind of economic activity So what defines a profit motive –  The IRS uses a list of things to consider whether an activity is for profit      - all of which must be considered together: What is the possibility of profit? Does the taxpayer depend on the activity as a source of income? Is the activity carried out in a businesslike manner? How much time and effort does the taxpayer spend on the activity? Are losses from the activity the result of sources beyond the taxpayer’s control? Has the taxpayer changed business methods in attempts to improve profitability? What is the taxpayer’s expertise in the field? What success has the taxpayer had in similar operations? Will there be a possibility of profit from asset appreciation? Presumption of profit motive: If an activity shows a profit for any 3 or more years during a period of 5 consecutive years then the IRS will presume that a taxpayer has a profit motive Note:  if the activity involves breeding, training, showing or racing horses, the period is 2 out of 7 years Of course, any activity that is reported on a tax return as a business but has had year after year of losses and no gains will probably eventually come under scrutiny by the IRS Tax Treatment of Hobbies - if an activity is deemed to be a hobby, then “hobby loss” rules – apply. Under these rules, any income from the hobby is reported on the face of the tax return, and the expenses are only deductible if a taxpayer itemizes their deductions on Schedule A. In addition, hobby expenses are limited by category as follows: Category 1:  In this category expenses are reported on the appropriate lines of Schedule A as they would be if no hobby activity existed and includes deductions for home mortgage interest, taxes, and casualty losses Category 2:  Most expenses that a business would incur, such as those for advertising, insurance premiums, interest, utilities, wages, etc., belong in this category. They don’t result in an adjustment to the basis of property but only to the extent that gross income from the activity is greater than the deductions under Cat 1 Category 3:  Depreciation and amortization belong in this last category. These deductions are allowed, but only to the extent that the gross income from the activity exceeds the deductions under categories 1 & 2 above. In other words category 3 is not intended to create a loss as a net result Note:  Taxpayers have to claim the amounts in categories (2) and (3) (as miscellaneous deductions on Schedule A) which are subject to the 2% AGI reduction; as a result, they are not deductible for AMT 2.   Call Cliff at (949) 813-1349