CORPORATE TAXES

ENJOY, PROPER, LOVE

Hobby or Business?

In general, the Internal Revenue Service (IRS) considers an activity a business if "it is carried on with the reasonable expectation of earning a profit." One way the IRS determines if your side activity is a business is whether you were able to show a profit in three of the last five years.

In addition, the IRS outlines nine factors to use as guidance when trying to determine whether your side gig should be treated as a business or hobby on your tax return. The factors are:

1. Whether you carry on the activity in a businesslike manner
2. Whether the time and effort you put into the activity indicate you intend to make it profitable
3. Whether you depend on income from the activity for your livelihood
4. Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business)
5. Whether you change your methods of operation in an attempt to improve profitability
6. Whether you or your advisors have the knowledge needed to carry on the activity as a successful business
7. Whether you were successful in making a profit in similar activities in the past
8. Whether the activity makes a profit in some years and how much profit it makes
9. Whether you can expect to make a profit from the appreciation of the assets used in the activity

According to the IRS, there isn't a single factor that carries more weight than others and the IRS could take into account other criteria beyond the nine listed. When answering the above questions, simply having more of your answers point toward your side activity being a hobby doesn't necessarily mean you didn't have a profit motive and you can't treat your side gig as a business for tax purposes. Each situation is different and it's best to consult with a tax professional for your specific scenario. 

Why It Matters

Whether or not your side gig qualifies as a business, any income generated from your moonlighting will appear on your tax return as income and will be taxed. However, it's the expenses that are associated with generating that income that are impacted by whether your side job is a hobby or business.

The IRS is keenly interested in this distinction as it estimates that the incorrect deduction of hobby expenses allowed taxpayers to avoid paying $2.8 billion in taxes in 2005. 

If your side gig qualifies as a business, then you can fill out Schedule C with your 1040 tax return and write off most expenses incurred in generating your side income. A loss for the year could be used to offset income from your day job. 

Jeff Rose, a Certified Financial Planner and founder of GoodFinancialCents.com, offers this advice on tracking side hustle expenses. "Keep all of your receipts for everything that involves your side business," he says. "Better yet, if you truly believe this side hustle will make money, then opening a separate credit card that is strictly for the side business will save you a ton of time and headaches come tax time."

If your side project does not qualify as a business, but rather as a hobby, then you won't be able to deduct expenses dollar for dollar. Instead, you'll have to put expenses on your Schedule A as a miscellaneous deduction. In order for the expenses to be deductible, you have to itemize deductions instead of taking the standard deduction, and only expenses that exceed 2% of your adjusted gross income will be taken into account. You'll only be able to deduct expenses to the extent of hobby income. That is, if you incur a loss in your hobby, you wouldn't be able to write off that loss against other income. In addition, if you are subject to the alternative minimum tax (AMT), your hobby expenses could be phased out completely since miscellaneous itemized deductions are not deductible for AMT purposes. 

Even if your side gig qualifies as a business, some expenses may be limited. For example, meal and entertainment expenses are typically limited to 50% of the gross amount. In addition, while you're able to take a home office deduction for the part of your home you use exclusively for your business, the home office deduction can't push you into having a net operating loss. 

Open for Business?

Before going out to buy that camera thinking you can deduct it as a business expense, review the nine factors the IRS takes into account when determining whether your side gig is a business or hobby. Unfortunately, each person's circumstances are different, so it may not be crystal clear whether your side activity is a business or hobby. Luckily, the IRS has also created a 64-page audit technique guide that may provide additional guidance and could serve as good bedtime reading. As an alternative to that torture, consider consulting a tax professional to determine how you should proceed. 

Ultimately, come tax time, you could file your side activity as a business or hobby. But if the IRS flags your tax return, the onus will be on you to prove that your side activity is actually a business with a profit motive, so be sure to keep accurate records, receipts and even a business plan to verify the validity of your side gig.

Business Taxation Meaning: Everything You Need to Know

The meaning of business taxation refers to the taxes that businesses must pay as a normal part of business operations.3 min read

1. Types of Business Taxes
2. Tax Liability
3. Calculating Business Taxes
 

The meaning of business taxation refers to the taxes that businesses must pay as a normal part of business operations. Whether you are a sole proprietor, partner, part of a limited liability company, or a corporation, your business is responsible for adhering to tax regulations. Each type of business will produce distinct tax consequences. Consider your business' tax concerns along with its non-tax concerns, so that you'll know which type of entity will help your business prosper and grow, or make it easier to pass on to heirs.

Types of Business Taxes

There are five major kinds of business taxes. They are:

In some industries, such as mining and insurance, companies will need to pay additional taxes. While businesses pay income tax, property tax, and sales tax, these taxes are not specific to business and are thus not generally considered business taxes. The reality of economic impact is that all taxes are "people taxes," as they impact people on a personal level.

Tax Liability

As a small business owner, you need to manage many different expenses, including your business' taxes. Several aspects of your company will require taxation, as enforced by the government. The amount of money you owe to federal, state, and local tax authorities is your tax liability. Tax money will be used by the government to fund administration and social programs.

As tax liability is a legally binding debt, you are required to pay the taxes you owe or you may face government penalties. Tax liability is a short-term liability, which means that you must pay it within a year. Short-term liabilities, such as tax liability, may be recorded together in your accounting workbook or balance sheet.

Any transaction that has a tax consequence is called a "taxable event". The government has the authority to determine which events are taxable. Any time a taxable event takes place at your business, you'll need to pay the associated tax authority. Taxable income, issuing payroll, and making sales are all taxable events. Different taxable events will require different amounts of tax liability, which are calculated as a percentage of the total event.

Selling a product is a taxable event for which the government may charge you sales tax. Instead of paying sales tax out of your own pocket, you can include the amount in the total price that you charge a customer. After you collect sales tax, you'll need to report it and send it to the appropriate government agencies. You can pay sales tax on a regular basis (quarterly or monthly). Earning income is another taxable event. Federal and state income tax liability is based on a percentage of your earned income.

Calculating Business Taxes

It's important to understand taxation processes and to know exactly when and how to perform business and personal transactions, in order to reduce your tax obligations. As a business owner and a taxpayer, there are typically multiple ways to complete a taxable transaction, one of which will result in the lowest legal tax liability. Remember, it's smart to avoid taxes, but it's illegal to evade them through concealment or deceit.

You may be able to deduct business expenses if you are engaged in a "trade or business," which means that you are conducting business activities for livelihood or profit. The IRS defines a trade or business as one in which both a profit motive and economic activity are present.

All of your taxable income will be calculated according to the tax year. All income received or accrued during a single year is recorded on that year's tax return, along with expenses paid or accrued. Once the tax year ends, any tax-saving strategies must have already been applied.

You'll also need to report your accounting method to the IRS. The two basic methods most applicable to small business owners are "cash" and "accrual." Under some circumstances, you might be able to use a hybrid that combines components of both. In addition, certain kinds of businesses may be allowed to use special accounting methods.

STATE TAX RETURN / FEDERAL TAX RETURN (1 YEAR)

$1,000.00 FOR ALL

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