The question of whether a taxpayer’s activity qualifies as a business or a hobby can be a close one, but it can significantly impact their tax returns.
Below, you’ll find a few of the top questions from a recent webinar on the topic and their accompanying answers. If you choose to attend the on-demand version of this webinar, you can access the full recording and the entire list of Q&As.
Q: Do you use three out of five years or two out of seven for agricultural businesses?
A: The two out of seven years rule applies specifically to activities involving the breeding, training, or showing of racing horses. All other agricultural activities continue to follow the three out of five years safe harbor rule.
Q: At what point do you have to report income as a hobby?
A: Technically, taxpayers should report any income they earn on their tax return, regardless of how minimal it is. This means that even income from a single sale must be reported.
Q: Just to clarify, hobby income is income LESS all expenses?
A: No. Currently, cost of goods sold (COGS) is the only expense that can reduce hobby income. COGS refers to the direct expenses associated with producing the item for sale. Other expenses are not deductible as they are considered miscellaneous itemized deductions subject to the 2% AGI limitation, which have been suspended at this time.
Q: How do hobby income, COGS and Form 1099-K, Payment Card and Third-Party Network Transactions, work together? Specifically, where do the numbers show up on the tax return?
A: Let’s say a client sells craft items on Etsy and has enough sales that a 1099-K is issued. You must determine whether the activity qualifies as a hobby or a trade or business. If it’s classified as a hobby, you report income net of COGS on Line 8j of the tax return.
To learn more about determining a not-for-profit hobby vs. for-profit trade or business, you can watch our on-demand webinar. NATP members can attend for free, depending on membership level! If you’re not an NATP member and want to learn more, join our completely free 30-day trial.
About National Association of Tax ProfessionalsThe National Association of Tax Professionals (NATP) is the largest association dedicated to equipping tax professionals with the resources, connections and education they need to provide the highest level of service to their clients. NATP is comprised of over 23,000 leading tax professionals who believe in a superior standard of ethics and exemplify professional excellence. Members rely on NATP to deliver professional connections, content expertise and advocacy that provides them with the support they need to best serve their clients. The organization welcomes all tax professionals in their quest to continually meet the needs of the public, no matter where they are in their careers.
The NATP headquarters is located in Appleton, WI. To learn more, visit www.natptax.com.
Information included in this article is accurate as of the publish date. This post is not reflective of tax law changes or IRS guidance that may have occurred after the date of publishing.