Q&A with Janese Shepard: Profitable ‘hobbies’ generally deemed taxable by the IRS

Jan. 13--Profitable 'hobbies' generally deemed taxable by the IRS

Q: Is income earned from hobbies, such as wedding photography, homemade birthday cakes or crafting, taxable?

A: Both hobby and business income is generally taxable. However, if your activities can be considered a business, then you can deduct the qualified expenses involved, even if they exceed the income that the business brings in.

Q: How does the Internal Revenue Service (IRS) define a business?

A: A key feature of a business is that it is undertaken to earn a profit. In the eyes of the IRS, an activity is presumed to be carried on for a profit if it's made a profit in at least three of the past five tax years, including the current year. There's a slightly longer horizon for businesses that involve breeding, showing, training or racing horses. If you haven't had the three years or more of profits, the IRS may take other factors into account.

Q: What other factors will the IRS consider?

A: The IRS will look at things like whether you carry on the activity in a businesslike manner; whether the time and effort you put into the activity indicate you intend to make it profitable; whether you depend on income from the activity for your livelihood; whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business); whether you change your methods of operation in an attempt to improve profitability; whether you or your advisers have the knowledge needed to carry on the activity as a successful business; whether you were successful in making a profit in similar activities in the past; whether the activity makes a profit in some years and how much profit it makes; and whether you can expect to make a future profit from the appreciation of the assets used in the activity. The IRS will weigh your answers to these questions, consider your specific circumstances and come up with a determination for each situation. Your certified public accountant can advise you not only on whether you likely qualify as a business under IRS rules, but also on the best strategic steps you can take to strengthen your company and put it on the road to greater productivity and profitability.

Q: How does the IRS define a hobby?

A: The IRS defines a hobby pretty much the same way we all do: something you do because you enjoy it, without necessarily expecting to make a profit. If you incur expenses -- on supplies, transportation, equipment or other costs -- related to your hobby, you may be able to deduct them, but there are limits. Generally, you only can deduct your hobby expenses up to the amount of hobby income. In addition, the expenses must be considered ordinary and necessary. An ordinary expense is one that is common and accepted for the activity. A necessary expense is one that is appropriate for the activity. Hobby expenses are reported on Schedule A as itemized deductions, generally subject to the 2 percent of adjusted gross income limit. Your CPA can help you ensure your tax return accurately reflects your activities and work with you to take steps that can help minimize your tax bill and achieve your other financial planning goals.

Q: What if someone doesn't have a CPA to help?

A: If you don't have a CPA and you live in Oklahoma, you can get a free referral and free 30-minute consultation at FindYourCPA.com. You'll be able to input specialties and a mileage radius acceptable to you for travel. It's pretty easy and, again, it's free.

PAULA BURKES, BUSINESS WRITER

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