How to maximize home business tax benefits

THESE TAXING TIMES

By Debra Speakes
Accountant

(Over the next few weeks, the Rim Country Gazette Blog will run a series of articles on tax preparation topics written by local accountant and tax preparer Debra Speakes, who operates Taxes by Phone! Accounting and Tax Services in Star Valley.  Click TAXING TIMES at the right to read the first three articles in the series.)

Today we will talk about small home-based businesses, such as people who sell on the internet.

Many people have the mistaken idea that they only need to report if their sales are over a certain amount. This is not true. There are amounts under which you will not get a 1099, but you still have to report the income. But there are different ways to report that have vastly different tax consequences.

There are four main scenarios I will talk about. Note that for each category, it doesn’t matter if the sales were made online or in person – the tax consequences are the same.

“Garage salers” are people who sell used stuff that they don’t need any more, and they aren’t making any profits – they are incurring a Capital Loss. While technically the proceeds could be reported on Schedule D, the result will always be a loss that cannot be deducted. So whether you report it or not doesn’t really matter much – you won’t owe any taxes anyway and the IRS doesn’t really want to know about it. Stick the $100 in your pocket and don’t worry about it. This is true whether you actually have a garage sale, or sell the stuff online.

“Hobbyists” are people who sell stuff at a profit, but mostly for fun. Maybe you like to crochet, and occasionally sell an afghan on etsy.com. Maybe you like to go to yard sales and look for bargains that you can resell on bonanzle.com. (eBay isn’t the only game in town any more.)

The downside to being a hobbyist is that your income is taxable as “Other Income” on form 1040 but your expenses are a Schedule A deduction, and only up to the amount of your profits. If you take the standard deduction, you can’t get any benefit from the expenses.

The good news is that you don’t have to pay that 15.4% Self Employment tax on your earnings. The bad news is you cannot deduct a net loss connected with a hobby. (The technical term is “hobby engaged in for profit” which only applies if you actually have a profit.)

“Online businesses” are people who are selling online to actually try to make a profit. Some people make their living selling online out of their homes. They buy merchandise, either new from a wholesaler, or used, maybe from yard sales, and resell it for a profit. Resalers should be registered with the state and collect sales tax if they sell to anyone in their own state.

They will fill out a Schedule C and will deduct their expenses and mileage, and likely qualify for a home office deduction. If you keep inventory at your home, the space used will be part of your home office deduction. You will deduct your selling fees, Paypal or credit card fees, postage costs, mileage to the post office or office supply store, and, of course, the cost of the items you sold. You will take depreciation on your computer and desk. You will pay self employment taxes on your net profit and will deduct any overall loss against your other income.

You need to conduct yourself in a businesslike manner, have a business license if required, do proper bookkeeping, and keep your receipts and mileage records. Note that if you have several years of losses, the IRS may decide you are really a hobby, and your net loss will not be deductible. You can find more about this on irs.gov.

“Capital gains” are a fourth possible tax category. If you sell a vintage apple press that cost you $200 at a yard sale 10 years ago that is now worth $500 to an antiques collector, you have a capital gain. You report this sale on Schedule D and pay capital gains tax on the profit. But since you are not in the business of selling antiques, you will not file a Schedule C and will not pay SE taxes on the profit.

So what happens if you lose money on most things and make a big profit on a few things? Can you deduct the losses against the gains? Sorry, no, you can’t. Capital losses on non-business items are not deductible, not even against gains on similar items.

And yes, it’s not fair that you have to pay tax on the gains but can’t claim the losses. But nobody ever said the tax code was fair.

(Debra Speakes is a degreed accountant and tax preparer who operates Taxes By Phone! tax, accounting, and business consulting services in Star Valley. She can be reached at (928) 468-6167.)