Archive for Tax Deductions

Hobby or Small Business?

Filing folders and tabs to organize bills

Some of our hobbies are just that – something we do because we enjoy it & we all probably spend more money on the activity, whatever it is, than we’ve budgeted.

But when does a hobby become a business?

Hobby vs. Business

The key factor in answering the business vs. hobby question is whether or not you are doing it to make a profit.

If you are and if you do make a profit, guess what? That income is probably taxable business income.

At the same time, if you are making a profit on your “hobby”, that’s taxable income too. Surprised aren’t you?

So if income from both is taxable, why should you care which way it is classified?

Hobby vs. Business Taxation

From a taxation standpoint, there are some key differences:

• You can deduct business losses against other income, but not losses on hobbies.
• Hobby income is reported under “Other Income” on your personal Form 1040 tax return.
Hobby expenses are deducted on Schedule A, which means you have to itemize deductions in order to do so.
• Since hobby expenses are part of your Itemized Deductions, the expenses are subject to the deduction limitation that the expenses exceed 2% of your Adjusted Gross Income (AGI).
• Business expenses and income are reported on Schedule C, Profit or Loss from a Business. It doesn’t matter if you itemize your other deductions or not.
Hobby expenses are only deductible up to the amount of income you generate from it.
• To deduct hobby expenses, you need to pass the IRS litmus test that you are actually engaging in your hobby to make a profit.

IRS and the Hobby vs. Business Question

Here are some of the questions the IRS uses to decide if it is a business:
• Is your “hobby” carried on in a businesslike manner?
• Does the time and effort you put into the “hobby” show that your intention is to generate a profit?
• Do you depend on income from the “hobby” for your livelihood?
• Are your losses are due to circumstances beyond your control (or normal in the startup phase of your type of business)?
• Do you adjust your operations to improve profitability?
• Do you have the knowledge required to operate this “hobby” as a successful business?
• Have you been successful in making a profit in similar activities in the past?
Does the “hobby” make a profit in some years and how much profit does it make?
• Can you expect to profit from the future appreciation of the assets?

Still not sure?

If you want to delve into this more extensively, consult your financial advisor or check out the information in IRS Publication 535 “Business Expenses”.

Whatever the business vs. hobby determination for tax purposes, have some fun doing it.


Home Office Tax Deduction Options

Home officeIf you use a portion of your home exclusively as a home office, you can usually deduct it as a business expense.

And if you use a portion of your home exclusively for other business uses, such as product storage, you may also be able to deduct that expense.

There are two options available to calculate the tax deduction.

The simplified version uses a cost of $5 per square foot up to a maximum of 300 square feet.

The traditional calculation requires filing Form 8829 with your tax return.

Form 8829 requires you to detail all the related costs of your home business use and may result in a higher deduction in return for the greater effort of filling out the form.

IRS Publication 587 gives you all the details or you can discuss it with your tax preparer to see if you qualify.


Get a Tax Deduction for Unreimbursed Employee Business Expenses

employee business expense tax deductionsPaying for business expenses or business related auto expenses out of your own pocket?

If your company does not or cannot reimburse the expenses, you might be able to use them as a personal tax deduction.

How to Claim Business Expenses

Unreimbursed business expenses can be claimed on Schedule A (Itemized Deductions) of your 1040 tax return.

If you don’t itemize your deductions or if your total itemized deductions do not exceed your Standard Deduction, there is effectively no tax deduction benefit to be gained from the expenses.

If you do itemize, then here’s the process:

  • Fill out Form 2106 or Form 2106EZ on which you will calculate your deductible amount for qualifying expenses
  • Take the amount on Form 2106 and list it on Schedule A in the appropriate place

What is a Qualifying Expense?

To be a deductible employee business expense, they must be:

Paid for or incurred in the tax year

• Be necessary and ordinary expenses in the course of your employment

• Related to performing your specific job or trade

Unreimbursed by your employer

What Types of Expenses are Deductible?

Necessary and ordinary expenses differ by trade or profession and can include, but are not limited to:

  • Licenses
  • Professional dues
  • Union dues
  • Uniforms
  • Tools
  • Vehicle expenses
  • Insurance premiums
  • Job related continuing education
  • Work related travel
  • Business use of your home

Are There Limitations?

Yes. Employee Business Expenses plus other Miscellaneous Expenses detailed on Schedule A must exceed 2% of Adjusted Gross Income (AGI) floor before being deductible.

If you have unreimbursed employee expenses, it is worth taking the time to do the calculation as it could lower your tax bill. If you don’t bother to do so, you’ll potentially be leaving money on the table.


‘Tis the Season to Give – 6 Tips on Deducting Charitable Donations

paper calendar pages flippingAs we move into the end of 2017, many folks are looking at making their final charitable donations for the year. Here are a few tax related tips:

1. The IRS requires written documentation for donations of ANY amount – keep your credit card statements, check copies or electronic transfer confirmations. The documentation should show the name of the charity, the date & the amount. Also, don’t throw away the thank you letter you get after the charity receives your donation as that counts as documentation.

2. For non-cash donations (e.g., furniture, electronics, household items) get a written receipt from the charity that includes a description of the items. If you use a self service type of drop box, make a written record of what you dropped off, the date & charitable organization’s name.

3. Non-cash donations are deductible based on their Fair Market Value, not what you originally paid for the item.

4. Contributions charged to a credit card are generally deductible on the date charged, not the date the credit card is paid. So if you contribute to a charity using your credit card in December, it will count for your 2015 taxes – even if you pay the bill in 2016 (subject to any other limitations on your deductions).

5. If you are getting something of value in return for the donation, it affects the deductible amount for tax purposes. The tax deductible amount is reduced by the value of the item received. The acknowledgment from the charity should detail this for you, but check with your accountant if you aren’t sure how much to deduct.

6. If you rely on your bank to store all the copies of your checks & transfers online for easy access, don’t forget to save them electronically or by printing if you decide to switch banks. Once the account is closed, it’s costly & time consuming to try to retrieve copies of old transactions.

You can find more donation deduction information on the IRS site or ask your accountant.


Home Office Deduction – Audit Flag?

womanin home office with paperworkMany people think that taking the home office deduction on their personal taxes is a good way to get audited. But since many small businesses are run out of home offices, not taking the deduction you are entitled to means you are leaving money on the table.

There are two key tests for taking this deduction: you must use the space exclusively as a home office and it must be used on a regular basis as your principal place of doing business.  If you use a portion of your home for storage of samples or inventory or if you regularly meet with patients or clients in an area of your home, you may qualify for the deduction as well.

Successfully taking the deduction means keeping very good records. You’ll need to be able to show that the space is used exclusively for your business and you’ll have to keep good expense records to document your actual deductions.

A floor plan showing the area used for your business is a good way to start your documentation and it will help you to accurately make the calculation needed to apportion your expenses. The expense deduction is based on the percentage of the space in your home that is dedicated to your business, so you’ll need to make a square footage calculation.  By dividing the square footage used for your home office by the total square footage of your home, you’ll obtain the percentage you’ll use to calculate the deduction.

Check out IRS Publication 527 for all the details and the various activities that qualify.  If you have an accountant, discuss the best way to document your particular use for deduction purposes.