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April 16, 2019

Business vs. Hobby: The Tax Rules Have Changed

Podcast: Roth Strategies and Conversions

Small Business Owners Should Double-Check Their Tax Returns

Tax Calendar
Business vs. Hobby: The Tax Rules Have Changed
If you generate income from a passion such as cooking, woodworking, raising animals — or anything else — beware of the tax implications. They’ll vary depending on whether the activity is treated as a hobby or a business.

The bottom line: The income generated by your activity is taxable. But different rules apply to how income and related expenses are reported.

Factors to Consider

The IRS has identified several factors that should be considered when making the hobby vs. business distinction. The greater the extent to which these factors apply, the more likely your activity will be deemed a business.

For starters, in the event of an audit, the IRS will examine the time and effort you devote to the activity and whether you depend on income from the activity for your livelihood. Also, the IRS will likely view it as a business if any losses you’ve incurred are because of circumstances beyond your control, or they took place in what could be defined as the start-up phase of a company.

Profitability — past, present and future — is also important. If you change your operational methods to improve profitability, and you can expect future profits from the appreciation of assets used in the activity, the IRS is more likely to view it as a business. The agency may also consider whether you’ve previously made a profit in similar activities. Also, the intent to make a profit is a key factor.

The IRS always stresses that the final determination will be based on all the relevant facts and circumstances related to your activity.

Changes Under the TCJA

Under previous tax law, if the activity was deemed a hobby, you could still generally deduct ordinary and necessary expenses associated with it. But you had to deduct hobby expenses as miscellaneous itemized deduction items, so they could be written off only to the extent they exceeded 2% of adjusted gross income (AGI).

All of this has changed under the Tax Cuts and Jobs Act (TCJA). Beginning with the 2018 tax year and running through 2025, the TCJA eliminates write-offs for miscellaneous itemized deduction items previously subject to the 2% of AGI threshold.

Thus, if the activity is a hobby, you won’t be able to deduct expenses associated with it. However, you must still report all income from it. If, instead, the activity is considered a business, you can deduct the expenses associated with it. If the business activity results in a loss, you can deduct the loss from your other income in the same tax year, within certain limits.

An Issue to Address

Worried the IRS might re-characterize your business as a hobby? Contact our firm. We can help you address this issue on your 2018 return or assist you in perhaps filing an amended return, if appropriate.
Contact: David Howell, EA
Direct: 920.337.4550
Podcast: Roth IRA Strategies and Conversions
With tax rates at relatively low levels as a result of the Tax Cuts and Jobs Act, now may be the time for you to take advantage of a Roth IRA, if you are not already doing so.
Small Business Owners Should Double-Check Their Tax Returns
Now more than ever, small business owners need to double-check their tax returns before filing. Why? Because many of the changes ushered in by the Tax Cuts and Jobs Act take effect with the 2018 tax year.

So, if you’re about to file, perhaps slow down and go over your return one more time with your CPA. And if you’ve already filed, don’t forget that you can generally file an amended return within three years of the original filing or within two years of the date on which you paid the tax (whichever is later).

What are some new or expanded tax breaks? First, there’s the increase of bonus depreciation to 100% and expansion of qualified assets to include  used  assets — effective for assets acquired and placed in service after September 27, 2017, and before January 1, 2023. The Section 179 expensing limit has also been increased to $1 million and the expensing phaseout threshold has been raised to $2.5 million. (These amounts will be indexed for inflation after 2018.)

Some tax breaks have been reduced or even eliminated. For example, deductions for net interest expense exceeding 30% of a company’s adjustable taxable income are now disallowed (with some exceptions). There are also new limits on net operating loss deductions and on excessive employee compensation. Also limited are deductions for certain employee fringe benefits, such as entertainment and, in some circumstances, meals and transportation.

These are just a handful of the items that have undergone notable changes from last tax year to this one. We can help you identify how your small business has been affected and how to adjust your tax planning accordingly.
Contact: Maria Ideker, CPA
Direct: 608.793.30746
Tax Calendar
May 15  

  • Original due date for exempt organization returns (Form 990).

June 17  

  • Second quarter estimated tax payments for individuals, trusts, and calendar-year corporations are due today.
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