Well this was a long week. I finished a full size, all orifice audit by my favorite tax authority. Final count was no additional taxes due and a minor refund to come. One of the more interesting items was a ten minute conversation about one of my side business, pens. One out of five businesses caught their attention, pen making. Well not really as they looked at each one like I was hiding the crown jewels.
It started with the auditor questioning a large deduction for items purchased for pen making. All told it came to just over 6k in kits, wood, supplies and equipment. We started with a short discussion about what pen making was. Second they wanted to see itemized receipts for everything. When I gave them what was 95+% of the total they (he) wanted to claim that this might just be a hobby and not a business.
I pointed out at that point, without getting into specific numbers, that I had reported income from pen making/sales for five plus years in a row. Paid taxes on five plus years of income. Was told since I had no regular retail place of business that they question was not so clear cut in their (his) mind if this was a hobby pretending to be a business and the deduction might not be allowed. I guess a large umber of people pay extra income taxes so they can deduct a few dollars in deductions. Typical government concept pay more to save less.
So I changed gears. I asked him that if he ruled pens were a hobby did that mean that I could not deduct related expenses? Exactly he said. All my pen related deductions would be disallowed. So I asked did that meant that I would loose the entire 6K deduction on last years return? Yes he said. So I asked if I would be required to file an amended return? Yes he said that I would have to correct my return or he said that the IRS would do it. How nice of them.
So you know how busy the government is with this budget reduction and I felt sorry for the IRS. I asked him how far back they would go. He said that he would recommend three years but the IRS could go all the way back to my first pen deductions if they wished. So to save them time I pulled out 1040X amended returns for the previous three years. I had five with me but only gave him the most recent three years. Got to love Turbotax.
Since he wanted to eliminate the deductions I also eliminated all income related to pen making. I did point that out. At that point he shut up and read the numbers. It changed my 1040, not by a ton but it changed it none the less by over 30K for the three years. Better yet it reduced that stupid Alternate Minimum Tax that I hate. If he ruled it was a hobby I would loose the deductions for expenses but also I would not have to report the income. The total change to the bottom line was more than a little. He said he wanted to review this. Nothing to review I told him. Remove the deductions you have to remove the income right. To that he shook his head yes. So I said that is the new corrected return(s) if my side business is just a hobby. He sighed. That said it all to me.
I consulted years go with my CPA I used to deal with taxes. He said technically pen making was a hobby on a small scale. But he did say when/if I sold a lot of pens that I could be determined to be a business and have a tax liability. He suggested when I sold a lot of pens it might be better to declare the income and treat it like a business. So I did. and the IRS just agreed. I figured that I was lucky. If I had hid my income from my "hobby" the IRS would have declared it as a business and the back taxes with interest and penalties could have been big bucks.
He asked about EIN but agreed that no employees meant no need for one at this time.
The only question I still had to confront was sales taxes. Everything is sold to tax exempt schools or resale by others who are liable for the sales taxes. He asked about sales tax records and I explained my position and he left that alone. But if you sell a few grand of pens you better ask and answer these questions. Are you a business and do you need to declare income and pay taxes both income and sales taxes? Because without records I would have been in for an even longer week and perhaps a major tax bill. We are with the government and am here to help is a phrase that fills me with dread and now a smile.
It started with the auditor questioning a large deduction for items purchased for pen making. All told it came to just over 6k in kits, wood, supplies and equipment. We started with a short discussion about what pen making was. Second they wanted to see itemized receipts for everything. When I gave them what was 95+% of the total they (he) wanted to claim that this might just be a hobby and not a business.
I pointed out at that point, without getting into specific numbers, that I had reported income from pen making/sales for five plus years in a row. Paid taxes on five plus years of income. Was told since I had no regular retail place of business that they question was not so clear cut in their (his) mind if this was a hobby pretending to be a business and the deduction might not be allowed. I guess a large umber of people pay extra income taxes so they can deduct a few dollars in deductions. Typical government concept pay more to save less.
So I changed gears. I asked him that if he ruled pens were a hobby did that mean that I could not deduct related expenses? Exactly he said. All my pen related deductions would be disallowed. So I asked did that meant that I would loose the entire 6K deduction on last years return? Yes he said. So I asked if I would be required to file an amended return? Yes he said that I would have to correct my return or he said that the IRS would do it. How nice of them.
So you know how busy the government is with this budget reduction and I felt sorry for the IRS. I asked him how far back they would go. He said that he would recommend three years but the IRS could go all the way back to my first pen deductions if they wished. So to save them time I pulled out 1040X amended returns for the previous three years. I had five with me but only gave him the most recent three years. Got to love Turbotax.
Since he wanted to eliminate the deductions I also eliminated all income related to pen making. I did point that out. At that point he shut up and read the numbers. It changed my 1040, not by a ton but it changed it none the less by over 30K for the three years. Better yet it reduced that stupid Alternate Minimum Tax that I hate. If he ruled it was a hobby I would loose the deductions for expenses but also I would not have to report the income. The total change to the bottom line was more than a little. He said he wanted to review this. Nothing to review I told him. Remove the deductions you have to remove the income right. To that he shook his head yes. So I said that is the new corrected return(s) if my side business is just a hobby. He sighed. That said it all to me.
I consulted years go with my CPA I used to deal with taxes. He said technically pen making was a hobby on a small scale. But he did say when/if I sold a lot of pens that I could be determined to be a business and have a tax liability. He suggested when I sold a lot of pens it might be better to declare the income and treat it like a business. So I did. and the IRS just agreed. I figured that I was lucky. If I had hid my income from my "hobby" the IRS would have declared it as a business and the back taxes with interest and penalties could have been big bucks.
He asked about EIN but agreed that no employees meant no need for one at this time.
The only question I still had to confront was sales taxes. Everything is sold to tax exempt schools or resale by others who are liable for the sales taxes. He asked about sales tax records and I explained my position and he left that alone. But if you sell a few grand of pens you better ask and answer these questions. Are you a business and do you need to declare income and pay taxes both income and sales taxes? Because without records I would have been in for an even longer week and perhaps a major tax bill. We are with the government and am here to help is a phrase that fills me with dread and now a smile.
