What’s the difference between a hobby and a business? According to the IRS, it is whether or not you are trying to make a profit. If you are not trying to make a profit and just want to write off the cost of your hobby, then you are subject to the “hobby loss rules.”
Business losses (when expenses are greater than income) can offset other income on your tax return. The general rule is that your business must make a profit in at least three out of the last five tax years. Otherwise, the IRS is allowed to re-characterize it as a hobby. The reason this is a problem is because losses from hobbies can only be deducted up to the amount of income and only as a miscellaneous itemized deduction on Schedule A. This difference in treatment can significantly affect the amount of tax you pay.
The IRS provides this list to help you determine if you are in business or just enjoying your hobby:
- Does the time and effort put into the activity indicate an intention to make a profit?
- Do you depend on income from the activity?
- If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
- Have you changed methods of operation to improve profitability?
- Do you have the knowledge needed to carry on the activity as a successful business?
- Have you made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Do you expect to make a profit in the future from the appreciation of assets used in the activity?
If you are not sure if your business is just a hobby contact me for an evaluation.
I regularly get questions about whether or not to file 1099s. They are often surprised that more vendors and contractors need 1099s than they think. The list goes well beyond a freelancer you hire or a subcontractor you use.
In general, 1099s are required for payments over $600 made to individuals and partnerships – NOT corporations. The following is a list of common vendors you will need to issue 1099s for:
- Payments for services
- Payments for rent to landlords
- Payments for prizes and awards
- Payments to attorneys
The biggest exception to the general rules above is that a 1099 needs to be filed for attorneys and legal services even if they are a corporation.
Not sure if you should file a 1099? My theory is- if in doubt, file it. There is no problem if you file a 1099 you did not need to file. However, the IRS can hit you for up to $100 per 1099 you do not file if you needed to. Even worse, the IRS can disallow the corresponding deduction on your income tax return.
If you are divorced or separated your legal documents might have you either pay alimony to or receive alimony from your ex-spouse. When you receive alimony, you are required to report the income on your 1040, line 11 on the 2013 form. If you paid alimony, you are allowed to deduct it on your 1040, line 31a, even if you don’t itemize your deductions.
How does the IRS know when someone pays alimony and someone receives it? To get the adjustment for alimony paid you would need to list your ex’s social security number along side the amount. The IRS can then check the ex’s tax return to make sure he/she reported the income. If you don’t include your spouse’s social security number you can face a $50 penalty, and the IRS can disallow the deduction.
Make sure not to confuse alimony for child support. Child support is neither tax deductible to the payer nor taxable to the recipient.
There are more complicated issues around alimony, such as payments to third parties on behalf of an ex or payments for a jointly-owned home. If you are getting divorced, you need to consult a CPA regarding income tax planning issues.
Every year each individual is allowed to give an unlimited number of tax-free gifts. For 2014, that gift amount is $14,000. Also, direct payments of tuition to educational institutions or direct payments of medical care to providers made on behalf of another person are not subject to gift tax. However, if the payments must be direct- reimbursing the person for either is a taxable gift.
What does this mean? With a little creativity, large amounts of money can be moved around tax-free. Look at these examples:
- A couple has a married child. If each parent gives the child and the spouse the gift limit for the year, they can make four gifts and transfer $56,000 tax free.
- If grandma and grandpa want to help pay for college, they can write checks directly to Junior’s university and avoid paying gift tax.
Want to give a gift over $14,000? Contact me for information on making larger gifts.
I recently made a presentation to financial industry professionals regarding tax issues for Estate & Trusts gifts. Here is a movie of the slideshow presentation. Have questions? Feel free to contact me!
Youtube video: Estate, Trust & Gift Taxation 2014
Can’t find your copy of an old tax return? Not sure that you received all your 1099s or other tax forms this year? You can get the information from the IRS by requesting transcripts or copies of tax returns.
Transcripts show the important information of tax returns without reproducing the forms. You can often get transcripts faster than copies of actual forms, they usually contain the information a third party (such as a mortgage company) requires, and they are free! They can be requested for:
- Tax returns- this shows most line items of your tax return Form 1040.
- Tax account- this shows basic information such as marital status, type of return filed, adjusted gross income, and taxable income.
- Wage and income- this shows amounts reported on W-2s, 1099s, and 1098s.
The IRS has a system to get transcripts either online immediately or by mail. You can use the online Get Transcript system here.
My disclaimer- I tried to use the system to view my transcripts. It could not find my information and locked me out after a few tries.
Tax Return Copies
If you want a copy of the actual tax return you filed, that can be requested as well. You will need to fill out Form 4506 and pay $50 per return requested.
What is the best way to keep the Feds hands out of your Swiss bank account? Make sure you file your FBAR (Report of Foreign Bank and Financial Accounts) by the deadline on June 30, 2014. This filing requirement applies if you had a foreign bank account balance over $10,000 during the course of 2013. To file you need to complete the form FinCEN Report 114 electronically.
There are big penalties for not filing the FBAR. The penalties can range from $500 up to the greater of $100,000 or 50 percent of the account balances, and in some case criminal penalties can apply.
If you have an FBAR filing requirement there is a chance you might have other foreign reporting requirements as well. Contact a CPA to determine what your needs are.
Section 179 deductions are the tax magic that let you fully deduct capital assets in the year your purchase them. By combining Section 179 and the depreciation rules regarding purchasing automobiles for business, you can save a good amount of money.
Vehicles have special depreciation limits based on their size. Passenger cars have a total depreciation limit of $3,160, while trucks and vans have a limit of $3,460. Sport utility vehicles (SUVs) and trucks over 6,000 pounds, however, don’t have this depreciation limit- and the full $25,000 Section 179 deduction can be used for these vehicles. This gives you the biggest tax deduction when you buy a vehicle.
This website has a great list of vehicles that qualify for Section 179, including the Cadillac Escalade and the Mercedes-Benz GL-Class SUV: Awesome Vehicles that Qualify as a Write Off
When you purchase big ticket items such as computers, furniture, and equipment these are called capital expenditures. Usually these items last more than one year so we allocate the cost of them across the years of their use. This process is known as depreciation.
There are special rules for tax depreciation. If you know these rules, you can effectively expense significant purchases all in one year, which can be an effective tax strategy. For 2014, this is accomplished by taking advantage of Section 179 deductions.
Section 179 has a number of rules that must be followed to take advantage of it. It can only be used on certain purchased items such as machinery, equipment, furniture, fixtures, and signs. It cannot be taken on buildings, their structural components, or land. The items must be purchased for use in business, and if they are used for both business and personal they must be at least 50% business use to qualify. Finally, there is a limit on the deduction currently in place for 2014 of $25,000.
If you use your car for your business your CPA has probably told you to track your mileage. The reason is that there are two way to calculate the auto related costs for your car- actual expenses and standard mileage rate- and both rely on knowing the number of business miles you drove for the year. The great thing here is the IRS lets you chose the method that leads to a greater deduction.
You can keep track of and deduct the costs for actual auto expenses. These expenses would include gas, oil, repairs, tires, insurance, registration fees, licenses, and lease payments. If you use your car for anything personal your deduction is reduced. The way to calculate your business use is to track your business and total miles for the year. For example, if you drove 10,000 for business and 15,000 total, your business use percent would be 10,000 / 15,000 = 66.67% and you would only be allowed to deduct 66.67% of all of your auto expenses.
Standard Mileage Rate
For 2014 the standard mileage rate for business is 56 cents per mile. To determine your auto expenses using the standard mileage rate you multiply the rate times the number of business miles driven. For example if you drove 10,000 miles for the year your auto expense deduction would be 0.56 x 10,000 = $5,600.
Have trouble keeping track of your driving? There are aps you can use to make it easier. Check out Triplog that tracks your rides using GPS.