Tax Question, Losing Business of Jazz

[TromboneAl]

Each year my jazz career, when I figure in the cost of driving to gigs, rehearsals, etc., manages to lose about $1,000. It's a bother to keep track of all the miles and cash income, but I do it.

2007 will be the first year in which I have no income from a "real" job. However, I will be doing a large Roth IRA conversion.

So I figure it still makes sense to keep track of the jazz expenses, and fill out the Schedule C each year.

Correct?

 

[Meadbh]

Al, doesn't there have to be some reasonable expectation that a business will generate profit to be able to benefit from losses? If so, you might be singing the blues.

 

[audreyh1]

Yeah - I don't think you can keep writing off the expenses of a "hobby". And unless you start to turn a profit, the IRS will not consider it a business.

Audrey

 

[justin]

There's an irs pub out there that tells you what it means to reasonably expect to produce a profit. Something like you were profitable in 2 out of the last 3 years or something. It can't be a hobby.

 

[TromboneAl]

Well, I bring this up with my accountant every year. I recalled a ruling that it had to make a profit three years out of five.

But he would always tell me that if if was run like a business, and had a reasonable chance of making a profit, that I was OK. I seem to remember someone telling me that if the 3/5 law were true, Ford (or GM?) would be designated as a hobby. Ha ha.

Also, sometimes, as in 2006, some of the places I play send 1099 forms. I wonder what would happen there if I didn't do a schedule C.

I'll look into it some more, especially since I won't be using my accountant anymore.

 

[TromboneAl]

From IRS.GOV:

Is it a Business or a Hobby?

It is generally accepted that people prefer to make a living doing something they like. A hobby is an activity for which you do not expect to make a profit. If you do not carry on your business or investment activity to make a profit, you cannot use a loss from the activity to offset other income. Activities you do as a hobby, or mainly for sport or recreation, are often not entered into for profit.

The limit on not-for-profit losses applies to individuals, partnerships, estates trusts, and S corporations. For additional information on these entities, refer to business structures. It does not apply to corporations other than S corporations.

In determining whether you are carrying on an activity for profit, all the facts are taken into account. No one factor alone is decisive. Among the factors to consider are whether:

You carry on the activity in a business-like manner, Yes
The time and effort you put into the activity indicate you intend to make it profitable, Yes
You depend on income from the activity for your livelihood, No
Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business), Yes, I don't get paid enough
You change your methods of operation in an attempt to improve profitability,Yes
You, or your advisors, have the knowledge needed to carry on the activity as a successful business, Yes
You were successful in making a profit in similar activities in the past, No
The activity makes a profit in some years, and the amount of profit it makes, and No
You can expect to make a future profit from the appreciation of the assets used in the activity. I sound better every day!

Bottom line: It's debatable.

Pros of treating it as a business:
Save $150/year
Don't get audited because I got 1099's

Pros of not treating it as a business:
Don't get audited because IRS says: hobby
Don't have to keep track of income/expenses/mileage

 

[Nords]

Also, sometimes, as in 2006, some of the places I play send 1099 forms. I wonder what would happen there if I didn't do a schedule C.

Ooooh, I can answer that one!

"Dear Taxpayer: a recent review of our 1099 records indicates..."

When one of those places gives you a 1099 (if, for example, you've made $600 or more there in a year) then they also send a summary of those 1099s to the IRS as part of their form 1096 filing. So your copy of a 1099 is your warning to report that income somehow, even if it's not necessarily on a Schedule C.

 

[TromboneAl]

Right. And I sure don't want to pay tax on that income without deducting the expenses.

 

[TromboneAl]

More info:

Tax Tips for Musicians

 

[SecondCor521]

Pros of not treating it as a business:
Don't get audited because IRS says: hobby

Not quite. You might be audited, and the IRS might decide it's a hobby and not a business, but I think if you treat it like a business and behave in a business-like manner, you'll be OK. It's facts and circumstances type of stuff. What we did with our schedule C business were things like (a) had a dedicated area of the house, (b) had a business name registered with the secretary of state, (c) got a state sales tax exemption for purchases for resale, (d) had a separate business checking account and credit card, (e) deducted for a home office, (f) collected and remitted state quarterly sales tax, etc. The more of this kind of stuff you can show at an audit if you're audited, the better off you'll be IMHO.

Also, if you're retired I think you could argue that "You depend on income from the activity for your livelihood" doesn't apply.

2Cor521

 

[Nords]

And I sure don't want to pay tax on that income without deducting the expenses.

Another option would be to have the payer reimburse your expenses instead of paying you a salary. Or you could just be paid in beer.

But there's a bunch of pros & cons for both methods.

 

[Peaceful_Warrior]

I would continue to deduct it, and worst-case scenario is that the IRS says, "It's a hobby, not a business. So you owe us for the last X years you claimed this, plus interest at X% for the money." It's unlikely they'd tack on any actual penalties since you aren't actively trying to cheat the IRS.

Actually after reading this thread, I've decided to deduct the expenses for our website. Especially since we already do make a profit, and we are actively trying to grow the revenue stream.

 

[Cb]

T-Al...do you guys have a website, MySpace or any music online? I'd like to check out your rhythmic stylings...

Cb

 

[igsoy]

Al,
It might be a little sketchy to keep taking a loss if you have never shown any sort of profit, they might spank you one of these years.

Maybe you could not take all your deductions on your schedule C every couple of years. Come out with a couple hundred profit, I think if it's less than $400 or something you don't have to file the SelfEmployment tax form. That way you pay a tiny amount of tax maybe 2 out of 5 years to take a bigger loss the other 3 of 5 years. (or vice versa?) Then they won't be able to call you on it.

 

[TromboneAl]

Maybe you could not take all your deductions on your schedule C every couple of years.

I've considered that, but heard that that is just as illegal as not reporting income.

do you guys have a website,

Yes, PM me with an email address and I'll send you a link. I'd post it here, but I like to keep somewhat anonymous on public forums.

 

[igsoy]

I've considered that, but heard that that is just as illegal as not reporting income.

Geez, Al, I had never heard that. Does that mean I'm in trouble for not recording/deducting for parking and tolls for the last 10 years because it's too much trouble? Yikes! I just figured the feds would endorse slackery[size=10pt]TM[/size] if it resulted in their getting paid more.

 

[runchman]

I kinda wonder about the hobby loss rules as well - I own a small laundromat, and it puts money in my pocket during the year, but when tax time comes it shows a loss because of the depreciation.

Depreciation shows up as an 'expense', even though it doesn't really come out of your pocket.

So in reality I'm making money, but on paper I'm losing. Of course I'll take it in the shorts when I sell and you 'recapture' that depreciation.

I wonder how the irs determines who to audit, if they look at the potential $$$ income that they can get per hour of auditor time.

If so, we rinky-dink little operations are probably relatively safe..??

- John

 

[retire@40]

...Depreciation shows up as an 'expense', even though it doesn't really come out of your pocket...

Then where does it come from?

At some point, the expense does come out of your pocket.

 

[TromboneAl]

Does that mean I'm in trouble for not recording/deducting for parking and tolls for the last 10 years because it's too much trouble?

Well, when you put it like that, it doesn't sound bad.

If I didn't record car miles (as in weekly 60 mile trip to drummer's for rehearsal), I could make a profit. But I would be giving false information in order to reduce my taxes in the long run.

 

[retire@40]

...Maybe you could not take all your deductions on your schedule C every couple of years...

Illegal.

 

[d]

Illegal.

why would it be illegal to not claim expenses?
would it also be illegal for him to claim income which was in fact never received?

 

[retire@40]

why would it be illegal to not claim expenses?

Because you'd be in violation of Rev Rul 56-407

would it also be illegal for him to claim income which was in fact never received?

Someone would either have to be 1) very stupid or 2) very conniving to want to report income that was never received.

Under the "stupid" category, I would say it would not be illegal.

Under the "conniving" category, I would say it would be illegal.

 

[Craig]

In my nefarious past, I was a Tax Manager at KPMG. But, that was so long ago, my tax knowledge is probably less than most of the folks on this board.


The debate is hitting all the hot points. In the final analysis Al, an auditor would probably tell you that you can take deductions up to the amount of your 1099 income ... anything else would be disallowed as a hobby loss.

The practical answer is that your numbers are small enough (no offense ) that this is unlikely to get much scrutiny. From what you're telling us, I assume your net annual loss is $450 to $600.

'Course, the real solution is a top 40 song, go platinum, make $1M, and blow this popsicle stand ... at which point you have a different tax problem.

 

[runchman]

Then where does it come from?

At some point, the expense does come out of your pocket.

The theory is that this expense is money you are setting aside to eventually replace your equipment.

In reality you don't set the money aside, then sell your laundromat for pennies on the dollar years down the road when your equipment is all old crap So that is when it comes out of your pocket, I suppose.

- John

 

[retire@40]

The theory is that this expense is money you are setting aside to eventually replace your equipment.

In reality you don't set the money aside, then sell your laundromat for pennies on the dollar years down the road when your equipment is all old crap So that is when it comes out of your pocket, I suppose.

I never heard of that theory.

The only theory I heard of is the theory of the allocation process whereby a cost (that already happened, not one that will or may happen) is allocated to future periods in order to match costs with revenues.

So, depreciation is an apportionment of a past expense that was not fully recognized as an expense in the past.