Tax Strategies for Hobby-Businesses

In my last article I discussed the insurance impact of insulator collecting. We touched on the subject of the "Business Pursuit" exemptions in typical home-owners policies and how it may be advantageous to classify your collecting as non-business or not a business pursuit. In this article I would like to briefly discuss the other edge of that sword. When would it be advantageous to classify your hobby activity as a side or even primary business? Tax time, that's when.

If your insulator collecting activities enable you to sometimes earn some money, your collecting may actually be a business and you may be entitled to some tax benefits. All income generated by a hobby is taxable. Expenses from carrying on such activity are, of course, not deductible unless offset against hobby income. For example, if your collecting activities generate $3000.00 of hobby income, then deductions can be taken up to that amount and are miscellaneous itemized deductions, provided they exceed two percent of your adjusted gross income. If your hobby, however, is classified as a side business you are entitled to additional business-expense deductions without limitation.

Once again we are put in the unsavory position of trying to fit into the definition of business or non-business. Note that an insurance company in determining coverage questions will obviously be much broader in their determination of what a business is than the IRS, so as to deny coverage. The Internal Revenue Service and the courts look at numerous factors in determining whether an activity is a hobby or a business. The most important factor is whether your predominant motive and goal in doing the activity is profit. Some of the factors that are used to determine whether an activity is primarily engaged in for profit are:

The business-like manner in which the activity is conducted. For example, how are the books kept, what operating procedures are used, etc.

The degree of expertise of the tax payer in the field.

The time and effort that is devoted to the activity. The more personal time and greater effort, the easier it is to establish profit motive.

The profit expectation from the activity and the assets used in the activity. The prospect that the assets will appreciate in value and produce an eventual gain figures favorably in showing a profit motive. (Insulators are appreciating and should sell for more five years from now).

The tax-payer's track record of income or loss from the activity. Losses during the initial start-up years do not preclude establishing a profit motive. Many years of consistent losses, however, may be less favorable, although not necessarily fatal.

The amount and frequency of occasional profit.

Financial state of the taxpayer. A taxpayer's lack of income from another source may be relevant.

The degree of personal pleasure or satisfaction derived from the activity. The presence of recreational or personal motive may indicate a lack of profit motive.

Courts will generally apply a presumption that an activity that turns a profit in three or more of five consecutive years is a business. This is not, however a steadfast rule. The upshot of this is that there may be a way to deduct the gas, mileage and wear-and-tear on your car going to and from shows, the loss you experienced in buying that big collection and so on. 

Remember that the first place, and sometimes the only place, an insurance company will look to determine business pursuit in deciding coverage questions is your tax returns. If you take the position that your collecting activities are actually a business for tax reasons, you will certainly lose the ability to classify them as non-business pursuit for insurance purposes. 

These issues have been discussed here in a very brief and general manner. If you have considering classifying your collecting activities as a business for tax reasons, I high recommend you consult with an accountant or tax attorney. .