Business & Finance Blog

The Internal Revenue Service reminds taxpayers to follow appropriate guidelines when determining whether an activity is engaged in for profit, such as a business or investment activity, or is engaged in as a hobby.

Internal Revenue Code Section 183 (Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the “hobby loss rule.”

Taxpayers may need a clearer understanding of what constitutes an activity engaged in for profit and the tax implications of incorrectly treating hobby activities as activities engaged in for profit. This educational fact sheet provides information for determining if an activity qualifies as an activity engaged in for profit and what limitations apply if the activity was not engaged in for profit.

Is your hobby really an activity engaged in for profit?

In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business or for the production of income.  Trade or business activities and activities engaged in for the production of income are activities engaged in for profit.

The following factors, although not all inclusive, may help you to determine whether your activity is an activity engaged in for profit or a 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?

An activity is presumed for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses).

If an activity is not for profit, losses from that activity may not be used to offset other income. An activity produces a loss when related expenses exceed income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.

What are allowable hobby deductions under IRC 183?

If your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity.

Deductions for hobby activities are claimed as itemized deductions on Schedule A, Form 1040. These deductions must be taken in the following order and only to the extent stated in each of three categories:

• Deductions that a taxpayer may claim for certain personal expenses, such as home mortgage interest and taxes, may be taken in full.
• Deductions that don’t result in an adjustment to the basis of property, such as advertising, insurance premiums and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.
• Deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.

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When your company’s debt is forgiven, you include the cancelled amount in gross income for tax purposes. The exception is cancellation of a debt to the extent that the payment would have been a deduction.

Problem: SmallCo uses a consulting firm from it which it obtains services on credit. SmallCo has trouble paying its debts, but is neither bankrupt nor insolvent, so the consulting firm forgives part of its invoice to SmallCo. If you are SmallCo’s bookkeeper, how do you book the cancellation?

Solution: The solution depends on SmallCo’s method of accounting:

• If SmallCo is on the accrual basis, it includes cancellation of the debt as income because, under the accrual method, expenses are recognized when incurred, not when paid.

• If SmallCo is on the cash basis, it does not include the debt cancellation in income because payment for the services would have been a deductible business expense.

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Is your auto worth less than the loan balance you have to repay on it?  If so, you are “upside down” in the world of the auto trade.  And that’s not a good place to be.

Unfortunately, that situation has become more common as consumers sought longer-term loans in order to get their monthly payments down to an affordable level.  Loans of up to seven years-that’s 84 months.-are now being offered to some buyers.

The average length of a new car loan from an auto finance company was 63.1 months in April 2008, up from 53.8 months in April 2000, according to the Federal Reserve’s report on consumer credit.

To stay upright, try to limit an auto loan to the number of years you plan to own the vehicle.

I just got back from the grocery store.  My goodness, Downy Softner is 9 bucks now.  Here are some tips on how to save money on groceries.

1. Use coupons
2. Buy in bulk (Costco)
3. Cut back on eating out
4. Plan ahead, cook ahead and freeze
5. Bring lunch to work
6. Buy cheaper or knock-off brand.

Times are tough lately and you are for sure not saving at the gas pumps.  To make it, it’s important to find ways to cut back on money.  Here are 5 ways to cut your auto insurance bill.

1. Increase your deductible - While this may save you money per month, you need to make sure that you have the money for the deductible should you have an accident.
2. Drive safely - Taking extra precautions while driving, staying under the speed limit and avoiding sudden stops and starts can help save on gas. Most insurance companies give discounts if you are accident-free for X amount of years.
3. See if you qualify for discounts - You may qualify for discounts by purchasing home and business insurance policies from within the same company.  Additionally, there are also discounts if you drive low miles, have multiple vehicles or your kids get good grades in school.
4. Reduce Coverage - Consider reducing your coverage if you are driving an older vehicle.  According to the Insurance Information Institute, it may not be cost effective to carry comp and collision on cars worth less than 10 times the amount you would pay for that portion of your coverage.  Try keeping the coverage, but raising your deductible.
5. Shop for a new provider - It’s always good to shop around every couple years.  In today’s world, there is usually a competitor out there that may give you a better deal.  Never hurts to look!

First-time homebuyers should begin planning now to take advantage of a new tax credit included in the recently enacted Housing and Economic Recovery Act of 2008.

Available for a limited time only, the credit:

• Applies to home purchases after April 8, 2008, and before July 1, 2009.
• Reduces a taxpayer’s tax bill or increases his or her refund, dollar for dollar.
• Is fully refundable, meaning that the credit will be paid out to eligible taxpayers, even if they owe no tax or the credit is more than the tax that they owe.

However, the credit operates much like an interest-free loan, because it must be repaid over a 15-year period. So, for example, an eligible taxpayer who buys a home today and properly claims the maximum available credit of $7,500 on his or her 2008 federal income tax return must begin repaying the credit by including one-fifteenth of this amount, or $500, as an additional tax on his or her 2010 return.

Eligible taxpayers will claim the credit on new IRS Form 5405. This form, along with further instructions on claiming the first-time homebuyer credit, will be included in 2008 tax forms and instructions and be available later this year on IRS.gov, the IRS Web site.

If you bought a home recently, or are considering buying one, the following questions and answers may help you determine whether you qualify for the credit.

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From aipb.org., here is a story about a successful freelancer.

Armelta Briggs, Consulting and Design, West Palm Beach, FL, has figured out a way to do only the work she likes, grow her practice-and have as much time as she likes to travel with her husband on his business trips.

Five years ago, she quit her full-time bookkeeping job to freelance and travel with her husband. Through a friend, she landed an assignment at a church showing employees how to use new software. Her work so impressed the church’s CPA, he started referring clients and her freelance practice was underway.

Despite Briggs’ decision not to advertise, market or attend business meetings, but to rely only on referrals, she doubled her last salary within 5 years.

“I get two kinds of referrals,” she explains, “big companies whose books are a mess and small businesses getting big enough to need bookkeeping.” For cleaning up the books, she charges $50-$70/hour, 2½ times the going rate for bookkeepers in her area; for routine work, her rate of $30/hour.

“Cleaning up problem books is my niche, and it’s what I enjoy most” she says. “I can do it without being given any direction, learn the software if needed and train the next bookkeeper on it. Software comes easily to me.”

Once the books are on track, Briggs spends 5-8 hours a week making sure they stay that way, then drops to once a month to check them. She says it averages $300/month per client, but can run over $1,000 if it includes daily data entry.

Briggs hates, and has avoided doing, data entry. Yet that is what small, growing businesses-and most of her referrals-need. So she hired a part-timer whom she pays $20/hour for data entry and charges the client $30. Once a month, Briggs reviews the books, does the bank rec, and checks the monthly financial statements.

Now that her business is growing without her having to do work she hates, she is starting to advertise, market and attend meetings where she can meet prospects-and she travels with her husband throughout the year.

The last of the economic stimulus checks have been issued under the planned payment schedule, which was a timetable for tax returns that were filed and processed before April 15.

However, the Internal Revenue Service will continue processing tax returns and issuing economic stimulus payments for much of the year.

It is not too late to file a return to claim an economic stimulus payment. The IRS urges people to file by October 15 to ensure they receive a payment prior to year’s end. It can take up to eight weeks for the IRS to process the return and issue the payment.

For people who have no tax liability or no tax filing requirement, there is a minimum payment of $300 ($600 for married couples), plus the $300 for each qualifying child. To be eligible for the minimum payment, individuals must have at least $3,000 in qualifying income.

Qualifying income includes any combination of earned income, nontaxable combat pay and certain benefit payments from Social Security, Veterans Affairs and Railroad Retirement. The IRS is continuing to work with numerous state, local and national partners to reach people who have no tax liability or no tax filing requirement and to help them file a simple Form 1040A.

Below are some links to IRS.gov and the U.S. Treasury regarding economic stimulus payments:

Also visit www.treas.gov to see the Treasury News Release Cumulative Economic Payment Totals.

Remember that for the genuine IRS Web site be sure to use .gov.  Don’t be confused by internet sites that end in .com, .net, .org or other designations instead of .gov. The address of the official IRS governmental Web site is www.irs.gov

Links:

• Haven’t received your payment yet?
• Form 1040A-3 for retirees, disabled veterans and others who normally don’t file a return

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The Internal Revenue Service is providing tax relief to victims of Hurricane Gustav in affected areas of Louisiana.

The IRS is postponing until Jan. 5, 2009 deadlines for taxpayers who reside or have a business in the disaster area. The postponement applies to return filing, tax payment and other time-sensitive acts otherwise due between Sept. 1, 2008 and Jan. 5, 2009. This includes:

• Individual estimated tax payments due Sept. 15, 2008.
• Corporate extended 1120 tax returns due Sept. 15, 2008.
• Individual extended 1040 tax returns due Oct. 15, 2008.

“As residents of Louisiana return to their homes following Hurricane Gustav, taxes are one thing they won’t need to worry about,” IRS Commissioner Doug Shulman said. “This relief gives them extra time to get their lives in order before having to deal with their tax matters.”

In addition, the IRS will waive the failure to deposit penalties for employment and excise deposits due on or after Sept. 1, 2008 and on or before Sept. 16, 2008 as long as the deposits are made by Sept. 16, 2008.

Other provisions are listed in the Grant of Relief section below.

Taxpayers who reside in or have a business located in the following parishes qualify for the relief announced today: Acadia, Allen, Ascension, Assumption, Avoyelles, Beauregard, Cameron, East Baton Rouge, East Feliciana, Evangeline, Iberia, Iberville, Jefferson, Jefferson Davis, Lafayette, Lafourche, Livingston, Orleans, Plaquemines, Pointe Coupee, Rapides, Sabine, St. Bernard, St. Charles, St. James, St. John the Baptist, St. Landry, St. Martin, St. Mary, Terrebonne, Vermilion, Vernon, West Baton Rouge and West Feliciana.

IRS computer systems automatically identify taxpayers located in the covered disaster area and apply automatic filing and payment relief. Affected taxpayers who reside or have a business located outside the covered disaster area must call the IRS disaster hotline at 1-866-562-5227 to request tax relief.

If an affected taxpayer receives a penalty notice from the IRS, the taxpayer should call the telephone number on the notice to have the IRS abate any interest and any late filing or late payment penalties that would otherwise apply. Penalties or interest will be abated only for taxpayers who have an original or extended filing or payment due date between Sept. 1, 2008 and Jan. 5, 2009.

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There is now tax relief for struggling homeowners. If your mortgage debt is partly or entirely forgiven during 2007, 2008 or 2009 you may be able to claim special tax relief by filling out Form 982 and attaching it to your federal income tax return for that year.

Normally, debt forgiveness results in taxable income. But under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude from tax up to $2 million of debt forgiven on your principal residence. The limit is $1 million for a married person filing a separate return.

Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, may qualify for this relief. The debt must have been used to buy, build or substantially improve your principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing.

Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the new tax-relief provision. In some cases, however, other kinds of tax relief, based on insolvency, for example, may be available. See Form 982 for details.

If your debt is reduced or eliminated you will receive a year-end statement (Form 1099-C) from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property given up through foreclosure.

The IRS urges borrowers to check the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven (Box 2) and the value listed for your home (Box 7).

For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit the IRS Web site at IRS.gov. A good resource is IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments. This publication and Form 982 can be downloaded from IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Remember that for the genuine IRS Web site be sure to use .gov. Don’t be confused by internet sites that end in .com, .net, .org or other designations instead of .gov. The address of the official IRS governmental Web site is www.irs.gov.

Links:

• IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments (PDF)
• Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (PDF)

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