It's not a business unless you treat it as a business.

Hi June,

I was at the Creative Freelancer Conference in San Diego last Summer where I attended one of your classes.

I have been buying software and hardware and traveling to workshops and designing for people that never paid. I don't have a "real" business or had advertised, but had word of mouth situations.

I'm obviously new to business and unfortunately I would do the work and then clients decide to bail on me.

The only income I have is unemployment.

All my expenses toward my "business" - could I use them in my taxes? I have a desk in my bedroom of my parents house since I lost my "real" job in 2008. I spent LOTS of money on my "business" but obviously no income. Is this even possible to turn in as an expense?

And what do you charge for this?
Christina


Dear Christina,

The IRS regs allow for business losses to be deducted from other income. But, the operative word here is "business." You must be a business.

In my book Self-employed Tax Solutions I pose the the question: How do I prove I am a business and in it to make money if I make no money? The answer: You must treat your endeavor like a business. I give a list of ways that you can show that you are treating what you do as a business.

You did not treat what you did as a business and so you cannot deduct the loss from your other income.

Here's my post that will give you more info HOBBY OR BUSINESS: Are you a professional artist?

There is no charge for answers posted on my blog.

-- June

Hobby or Business? If it's fun, be careful.

Well, here I am making another exception and taking on a unique situation. But since 2009 is to be the year of change, why not? And, I do think that there is enough in Guren's situation that many of you will get something from my answers. My response is in orange.
-- June


Hello June,

My wife and I are avid travelers and, although we have settled down and each work full-time as employees at different companies, we plan to start a travel blog with the goal of making enough money to fund even more traveling.

We will file a dba and work as a partnership. A partnership is the least tax advantageous structure for a husband and wife business. For some basics on that, read these posts payroll -- spouse as employee .

1 - it seems too good to be true that we could deduct the cost of our travel and other expenses against our blogging profit and, if there are losses (and I'm sure there will be in the first few years), deduct those losses from our regular employee incomes. If the losses are great enough, it would be like the IRS paying us to travel. Or am I dreaming? Your dream may become a nightmare unless you show a true profit motive. Your goal cannot simply be to save enough in taxes to pay for your travel. That very much has the ring of a home-made tax shelter to me and I'm sure would make the same sound to the IRS.

Your profession -- travel blogger -- falls into the same genre as skiing and photography and other activities that people do for fun and so the proof that you are in it to make a profit must be stronger than for other professions such as massage therapy or IT consultant.

The IRS lists nine guidelines that will help determine whether you’re goal is to make a profit. No single item on the list settles or resolves the issue, and the list includes questions such as:

Do you carry on your work in a businesslike manner? Do you keep accurate records of income and expenses? Have you had success in carrying on similar or dissimilar activities? Have you taken a similar activity and converted it from an unprofitable to a profitable enterprise? Have you had general success in running other kinds of businesses? Did you write a business plan on how your blogging is going to make money over the next 5 or 10 years?

2 - As long as we have losses, are we forbidden from contributing to a SEP retirement plan? For a SEP, and any other pension for self-employeds, the contribution is determined by net income. That means what you are left with after deducting business expenses. A loss means no pension contribution for the sole proprietor. If your spouse is your employee, then a loss does not have that same relationship to the spouse's pension contribution.

3 - any idea of what a indie-friendly CPA should charge for an initial consultation? Between $150 and $350 per hour. Depends on the geographic location and expertise of the tax pro.

I hope you're able to help!
Thanks in advance!
Guren
St Louis, MO

A related comment: There are so many books and sites that tout self-employment as a way to pay no tax. This is a concern of mine. I'll say more about it in this month's eLetter Ways Through the Maze. If you are not already on the mailing list and would like to subscribe, you may do so here.

--June

Artist is a Business

Dear June,

I am a full time art teacher and a working artist. I have a separate studio for my work in my home (rental), in Oakland, CA. My work has been shown in several gallery shows.

I just won a fellowship to attend an art retreat and build my online portfolio. The fellowship is taxed, and I am spending a considerable amount of money investing in my work, with the intent to show and sell my art professionally. I do not consider this a hobby, and will likely cut down my teaching load in the coming years as I set up a sustainable structure to sell my work.

Can I consider myself a business this year, even if I have a full time job and have not sold much artwork to date?

Also, are you planning to give any more seminars for women artists?

Thank you for your help!
Kimberley


Congratulations on your fellowship, Kimberley!

You say you are a working artist. If you are, and if you try to sell your art, then no matter how much or how little money you make, you are a self-employed in business. Any loss from your art business may be subtracted from your other income and so would lower your tax.

I have no seminars scheduled for California. There is a September seminar for women in Albuquerque, NM.

Best,
June

Exotic Dancer and more ...

I choose questions from indies that I think will be most helpful to the most people. I stay away from questions about unique situations that won't be informative to a lot of you. The situation below, from Michelle, although unique has a number of situations that apply to a lot of indies.

I've noted the distinct points or questions in red.


Hello June!

I have a very complicated question...or so I think! I am confused about pro vs hobby and what deductions I can take for this year.

My main job for the last 15 years has been as an exotic dancer. I am an independent contractor and have always filed a schedule C. I deduct traveling expenses (when working out of town) and supplies (costumes, shoes)

I am also a fine art photojournalist who is currently working on a photo documentary project to be published as a book. I plan on traveling often this year to shoot various photo projects and complete my book. I have also purchased plenty of supplies and equipment in this tax year as well and I have a home office dedicated as my studio. Since this is a ongoing project but I have received no income from it as of yet...can I still deduct travel expenses, equipment costs, home office, etc without profit?

Also, I have third business! I attended a yoga teacher training this year and will start teaching classes out of my studio (separate from the art studio) as of April 1st in my home. I have had to pay for paint, carpet, supplies to ready the studio for classes. I have been working on the studio since January and paying the extra rent myself. I do have a registered business name and business account. I will have very little profit by April 15. So am I entitled to deduct the home studio and start-up costs for the business this year? How about the teacher training and yoga classes as an education expense?

Since I have 3 separate businesses I am afraid of an audit due to all these deductions! What is proper protocol for multiple small businesses? Should I be worried about claiming too many deductions?

I would really like to do my taxes myself to avoid extra costs due to the fact I have paid a lot out of pocket to start up the yoga teaching and for photography equipment.

Your help will be greatly appreciated!

Thanks in advance!

Michelle
Portland, OR


Here's my response to Michelle:

The goal of a hobby is not to make money. The goal may be to have fun, help others, perfect a skill. A hobby may make money. You may deduct expenses only up to the amount of hobby income.

The goal of a business is to make money. As long as making a profit is your goal you don't have to actually make money. You may also enjoy yourself, help others, or master skills or develop a nascent talent. You may deduct all legitimate business expenses regardless the amount of income.

If the business is not yet "open for business" meaning you are not yet ready for clients or customers, then you are still in the start-up stage. Expenses may be deducted when the business opens. You may not deduct education costs to learn a new skill.

You say: I will have very little profit by April 15. April 15 is the first deadline for filing a tax return. It is, however, immaterial to income or profit. Calendar year taxpayers -- that's just about all of you -- group income and expenses from January 1 through December 31.

It would be unwise, time- and money-wasting to try to do your own tax return in order to save accounting fees. You have a complex three-indie-business tax situation; you lack knowledge of basic indie tax treatment; you have not had the time, or the rigor, to review my site and blog where you could have found all the answers to your questions. Would you teach yoga without first studying it? I wouldn't .

Put your time and energy into your businesses -- yoga classes, dancing, photos -- you'll earn more money, achieve success, and have the money to pay a tax pro.

A "donation" received for a product or service is income.

June --

I'd like take the whole question of hobby vs business and turn it on it's ear. I'm considering starting a side business which will offer computer software for free but accept donations. Using the guidance in your book, it seems to fall into the hobby category, mainly due to a lack of profit motive.

So the question is: Can my received donations be taxed and if so can I deduct expenses?

Thanks, Fraser from Colorado


Dear Fraser,

Be careful. Instead of turning something on its ear you could end up on your rear!

If you don't have a profit motive, then it's not a business and you may deduct certain expenses only up to the amount of income. The expenses are not a direct deduction and so they may end up giving you no actual deduction at all.

The "donations" are fully taxable to you as income. Something is a "gift" and not taxable as income only when the giver gives of his or her own free will and gets nothing in return . Not so in your case. The giver is getting software.

Stay upright!
June

Profit Motive: You're OK as long as you want to make a buck.

Chris thanked me for the Designers Dozen: Tax Saving Tips for the Graphic Artist post and then asked:
I recall that your new business can only lose money for a certain period of time before it's a hobby. Is that still true and if so, how long is that?

There is no time limit on losing money. That's hogwash! Never was a rule, an old husbands' tale, maybe. For a better understanding, think of it in reverse: If your business makes a profit in three out of five years you're home free. Notice that says that IF you make a profit not that you MUST make a profit.

As long as your goal is to make money, you're OK. The IRS says that in order for you to be engaged in a business rather than a hobby, the goal must be to make a profit. The IRS doesn't insist that you actually make a profit, but there must be a reasonable expectation of one.

How do you prove you're in it to make money if you're not making any money? That's too long to go into here but the full explanation is in my book, Self-employed Tax Solutions -- starts on page 11 with Cheech and Chong as the solo entrepreneur example.

HOBBY OR BUSINESS: Are you a professional artist?

Artists and designers and crafts people:
Does the IRS consider you a professional?

You’ve been chosen for juried shows. You sell your work. People praise its quality and design. You think of yourself as a professional artist. But … are you a professional in the eyes of the IRS? And why does that matter?

It matters because it can have a big impact on your taxes, especially if you spend more money pursuing your art or craft than you bring in.

Let’s say that in one year you spend $10,000 more in art expenses than you bring in as sales. Also in the same year, you receive $50,000 in income from Grandma's trust fund, or $50,000 salary from your corporate job. If your art or craft activity is a business rather than a hobby, then you get to subtract the $10,000 business loss from the $50,000 taxable income. You are now looking at taxable income of $40,000 instead of $50,000.

But you may deduct the art loss from Grandma's trust income or from any other taxable income only if the IRS considers your art activity a business.

Maybe you don’t think of yourself as a self-employed designer or craftsperson in business. Perhaps you’re still at the thinking-about-it stage of making your art your work or you love what you do so much you don’t think of it as a business. You may believe you’re not self-employed because you haven’t made any money. Or perhaps you know you’re in business but work only part-time at your art and doubt that the IRS would think you’re a business.

The IRS criteria on the issue comes in two parts.
· The first: Are you self-employed or are you an employee?
· The second: Are you doing what you’re doing as a hobby or is it a business?

With regard to the first question, the IRS has put together a guide to help determine whether someone is self-employed or an employee. The focus of that guide is upon a single issue – the issue of control. It looks at things like whether you use your own methods and set your own hours? Who directs and controls the money, that is, who pays the expenses of the business -- customer or worker?

To get an idea of how this works, here’s an example of two self-employed artists:

Glen Glass has a client who wants stained glass candle holders designed and made by July 1 as an anniversary gift for his wife. He will pay Glen $1,000. On July 1 the candle holders are ready. The client likes them. He gives Glen a check for $1,000.

Trixie Trinkets designs and makes jewelry. She sells a silver necklace to her friend for $1,000.

In neither case did the customer have any control over what hours to work, what supplies or equipment to use, or any other aspect of production. The customer is free, of course, to cancel the order or not buy the product but even that may be regulated by contract.

Both Glen and Trixie are self-employed. There’s more info on employee vs. self-employed at It's all about relationships: Are you an employee or are you self-employed?

Here’s the part that confuses many artists. Just because you are self-employed does not necessarily mean that you are also a business. This is where the second criteria comes in: The IRS says: “In order for you to be engaged in a business rather than a hobby the goal must be to make a profit.” But how do you prove to the IRS that your goal is to make money if you make no profit? Well, you have to show that you have a profit motive.

The IRS lists nine guidelines that will help you determine -- in case you had any doubts – whether you’re doing whatever you’re doing to make a buck. No single item on the list settles or resolves the issue, and the list includes items such as:
· Do you carry on your work in a businesslike manner? For instance, do you keep accurate records of income and expenses?
· Do you strive to learn more about your work? For instance, do you visit museums? Take design courses? Do you have business cards? Do you have copies of juried show applications you submitted?

Let’s look at a hobby and a business.

Aunt Ada lives nicely off the income generated from her investments. She enjoys quilting. She has given her quilts to nieces as wedding gifts and every once in a while an acquaintance or relative buys a quilt she’s made. Ada does not advertise. She sees her quilting income as play money. Whatever she makes she spends in Atlantic City testing her gambling skills.

Based on these facts, Aunt Ada has a hobby. If Ada sells $1,000 worth of quilts in a year she is allowed to deduct up to only $1,000 in quilting expenses, even if her costs were more than $1,000. Why? Because hers is a hobby, not a business.

Trixy Trinkets, unlike Aunt Ada, has no investments. She works as a design assistant at a clothing store where she earns $40,000 a year. Evenings and weekends she designs and makes silver jewelry. Unable to keep up with the requests of those who want to buy her unique pieces, she cuts back on the hours at her clothing store job to devote more time to designing, creating and selling her jewelry. She’s not sure how long it will take, but she’s determined to leave the clothing store eventually and make a living as a jewelry designer. She was an excellent apprentice to a highly respected silversmith in her town and even helped him redesign his studio. She keeps careful records of how long it takes her to complete each piece and sets her prices by her records and the going market rate. She advertises and keeps a record of income and expenses.

Based on these facts, Trixy is a self-employed jeweler. She is in business -- even before she quits her regular job.

If Trixy sells $1,000 worth of jewelry, she may deduct any amount of business expenses that she incurs even if they amount to many thousands of dollars. If Trixy has a net loss from her jewelry design business, that loss can be deducted from her other income and could reduce her taxes. For instance, If her expenses total $6,000, she would have a $5,000 loss. From her wages of $40,000, she may subtract her $5,000 loss, to arrive at taxable income of $35,000.

To sum up: To prove that your art is a business, treat it as one. Show that your aim is to make money. Then, if you end the year with a loss you have proof that such was not your intention. And you can deduct your losses without fear.