I am just back from a writer’s conference and since I’m a CPA with tax on my mind (always), one of the conversations I had more than once had to do with writers and their US taxes.
What do writers, or for that matter, anyone with a beginning business report? WHEN do they report the business on their tax return?
Let’s look at this from the perspective of a writer. This could be someone who is a blogger, someone who is writing a non-fiction home study course or someone who is writing the great American a novel. These are all forms of writing.
At some point, you have begun a business. The IRS usually determines it occurs when you have published. In today’s world of indie publishing, you could actually publish this weekend, just as soon as you set up a blog.
With a business, in this case the business of writing, you have deductions. Now comes the big question. Do you have a hobby or do you have a legitimate deduction? There are several reasons why this question is so important, post-Tax Cuts and Jobs Act (Trump Tax Plan.)
Effective 1/1/2018, a hobby must report all income without taking any deductions against it. In other words, if you sell something for $100 and have expenses of $100, you would assume that you’ve got a break-even. And that would be the case if it was a business. But if you have a hobby, you don’t get the deductions that in the past were reported as miscellaneous deductions on Schedule A for itemized deductions. Those deductions are gone and that means you report $100 and that is all taxable.
You pay more tax with hobbies.
And if you have a loss after taking advantage of all of the deductions, the loss is deductible against other income if you have a business. If you have a hobby, the loss is not deductible.
That all means that a hobby is definitely something to be avoided.
There are two ways that the IRS allows you to prove you have a business, not a hobby. (And remember, this is important. A business is good. A hobby is bad.)
First, you are allowed a safe harbor strategy. In fact, there are two of them.
- An activity is presumed to be a for-profit business if it produces positive taxable income (income in excess of deductions) for at least three out of every five years. Losses from the other years can be deducted because they are considered to be business losses as opposed to hobby losses.
- A horse racing, breeding, training, or showing activity is presumed to be a for-profit business if it produces positive taxable income in two out of every seven years.
Sometime people think that is the only way to prove that you have a business. However, this is just a safe harbor test. It’s not the only test, just the easiest one.
If you can’t meet the safe harbor test, don’t despair! You still have a shot at proving you have a business, not a hobby.
The “Other” Tests
Even if you don’t meet the safe harbor tests, you may still be able to show you have a business. You need to show that you have a true business intent. You intend to make a profit. Some of the factors that go into proving such intent include:
You are conducting your business in a business-like manner with good records. It’s also often a key step to have a business structure. Form an LLC (limited liability company) in your home state. Initially, you may want to use the Schedule C, Sole proprietorship, tax strategy.
You have expertise in the business venture or you hire/get regular coaching or mentorship from advisors who do. **We can help you with this if you’re looking for experienced business owners who also know how to present and read financial statements to spot trends. Our coaching program is an affordable way to plug into our system of experienced entrepreneurs. https://www.ustaxaid.com/coaching-program/
You spend enough time to demonstrate that you are serious about this being a business and not just a part-time hobby.
There is an expectation of asset appreciation.
You have had success in previous business ventures.
There is a justifiable and reasonable excuse for current losses. These could be due to unusual events or initial start-up costs, but whatever the reason, they are something that an average business owner would expect.
Your own financial status demonstrates that your expected profits make this venture a sound one.
Prove you have a business and the IRS lets you take deductions you can’t get personally. You’ll eventually make money and always pay less in tax. Don’t miss this critical step. Make sure you have a business.
Got a business or thinking about starting one? Make sure you have your tax planning in place. That means good record keeping and often a business structure. We can help! Check out the other blogs here at USTaxAid.com for information on setting up and running your business so the IRS lets you have the deductions you deserve.