-K8memphis Posted 26 Feb 2013 , 11:10pm
post #1 of

i know many of us believe if we get/charge one red cent it's a business

 

while we all are of course entitled to our own opinions i really think that one can charge for cake supplies and not be running a business according to the irs:

 

Quote:

Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit.

In order to make this determination, taxpayers should consider the following factors:

  • Does the time and effort put into the activity indicate an intention to make a profit?
no we're just nuts--hobbyists like to do this--make beautiful tasty edible creations
 
  • Does the taxpayer depend on income from the activity?
hobbyists would all starve to death if they did
 
  • If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
  • Has the taxpayer changed methods of operation to improve profitability?
  • Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
  • Has the taxpayer made a profit in similar activities in the past?
are you kidding?
 
  • Does the activity make a profit in some years?
not a chance in the very hot place
 
  • Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
gently used cake toys and slightly dented pans--i don't think so
 

The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year — at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses.

 

i remember being told on here something to the effect that generating any income at all is a business--rahr

 

but this says p.r.o.f.i.t--and profit is of course what's leftover after expenses--if all we take in is ingredient/material expenses we cannot possibly make a profit thus i think it says we are hobbyists

 

and i truly truly ishtabooli do not believe it constitutes a business

 

if a caker in the u.s. has no reasonable intention of making a profit and so many of us operate this way then yes we are engaging in a hobby

 

and there are some of us who intend to make a profit but we never will --those might be closet hobbyists :)

 

not trying to start a rip snorting debate--just putting this view out there from the irs

80 replies
remnant3333 Posted 26 Feb 2013 , 11:56pm
post #2 of

No one can argue with the IRS!!! Thanks for the information!!

VanillaSky Posted 27 Feb 2013 , 12:00am
post #3 of

Those IRS questions go to the deductibility of expenses and whether you have a hobby or a business, but even if you have a hobby and not a business, hobby income is taxable.  And state licensing requirements, if any, still apply as to whether you can legally accept money for cakes.  

texascakebaker Posted 27 Feb 2013 , 1:07am
post #4 of

This thread is just downright amusing! K8Memphis, you're right on!

 

Note that if you itemize on your tax return and you meet the 2% floor, you can deduct some of your hobby expenses...For example, for simplicity's sake, say you gross $1,000 for the year (aggregate sales price of all cakes "sold") and you spent $3,000 on ingredients, pans, cookie cutters, storage boxes, decorating books, Craftsy classes, etc. you have to report the $1,000 as income. Now, say your AGI is $100,000. 2.5% would be 2,500. SO, you can deduct expenses in excess of that amount, which would be $3,000-$2,500=$500 deductible. BUT that's only if you itemize...all the people out there who simply take the standard deduction are out of luck!

 

Now, isn't that a hoot?! icon_biggrin.gif

 

FromScratchSF Posted 27 Feb 2013 , 1:22am
post #5 of

I'm not offering any legal advice to anyone, but seriously ya'all, if you think less then 500 words copied and pasted from a tax website accurately sums up what is and is not a legal business and there is no other information required OR any other governing authorities that may have different rules and opinions, then we'd never need CPA's.  icon_biggrin.gif

 

I appreciate your original post, K8, but I fear you are beating a hornet's nest here.

Annabakescakes Posted 27 Feb 2013 , 1:22am
post #6 of
Quote:
Originally Posted by VanillaSky 

Those IRS questions go to the deductibility of expenses and whether you have a hobby or a business, but even if you have a hobby and not a business, hobby income is taxable.  And state licensing requirements, if any, still apply as to whether you can legally accept money for cakes.  

As do health department and food laws.

texascakebaker Posted 27 Feb 2013 , 1:32am
post #7 of

I'm working on my master's in accounting with an emphasis in taxation, so I have studied this extensively (far more than I have wanted to!). K8 is right. I'm not here to say everyone baking cakes has a hobby issue on their hands, but it is true that more goes in to determining whether selling cakes is a "business" or "hobby" as defined by the IRS.

 

 

Again, a lot of different factors have to be considered. And different CPAs will interpret the law differently. What I posted earlier is based on my strict interpretation of the laws. There are a lot of court cases out there that deal with this topic precisely.

-K8memphis Posted 27 Feb 2013 , 2:28am
post #8 of
jason_kraft Posted 27 Feb 2013 , 3:51am
post #9 of

AThe IRS's definition of a business vs. a hobby is for a very specific purpose: to make sure most business deductions that offset other income are the result of for-profit activity and not personal activity (e.g. a hobby). It is in fact more beneficial for the IRS to consider you a business than a hobby, which is the opposite of every other food safety and licensing dept (where a business can mean required inspections and additional fees).

If you have a fully licensed and inspected bakery it still is possible to be considered a hobby by the IRS if you post losses year after year and do not work to improve profitability (this would not be a good thing). If you bake from home, do not have a license or comply with local food safety laws, and only sell food for friends and family as a "hobby" it is also possible to be considered a business by the IRS, which is actually to your benefit.

The issue most often discussed on this forum is one of microeconomics...if you are advertising products for sale to the general public (even if that advertisement is just a web site or FB page), you are running a business, and you have a duty to at least have a general idea what market values are and price accordingly. This has absolutely nothing to do with how the IRS allows you to apply deductions to offset other income.

If you don't want to run a business, take down your web site and business FB page, do not mention that you sell cakes outside of your circle of family and friends, and do not accept orders from people outside your circle.

jason_kraft Posted 27 Feb 2013 , 4:03am

A

Original message sent by texascakebaker

Note that if you itemize on your tax return and you meet the 2% floor, you can deduct some of your hobby expenses...For example, for simplicity's sake, say you gross $1,000 for the year (aggregate sales price of all cakes "sold") and you spent $3,000 on ingredients, pans, cookie cutters, storage boxes, decorating books, Craftsy classes, etc. you have to report the $1,000 as income. Now, say your AGI is $100,000. 2.5% would be 2,500. SO, you can deduct expenses in excess of that amount, which would be $3,000-$2,500=$500 deductible. BUT that's only if you itemize...all the people out there who simply take the standard deduction are out of luck!

I believe you are only allowed to deduct hobby expenses (subject to the 2% floor) up to your hobby income. So in your example, since your hobby grossed $1000, you would only be able to deduct $1000 in hobby expenses. However, if you had no other misc expenses under Schedule A you would not reach the 2% AGI floor (assuming $100K AGI) and would not be able to deduct any hobby expenses, which means you would owe income tax on all of your hobby income.

http://www.nolo.com/legal-encyclopedia/can-you-deduct-your-expenses-from-hobby.html

Now if you were a business in the eyes of the IRS, you would be able to deduct the entire $3K (assuming valid business expenses of course). Not only would you not have to pay tax on your $1K cake income, but $2K of income from other sources would be tax-free as well.

texascakebaker Posted 27 Feb 2013 , 5:21am

Jason, yes, I got the limitations a little mixed up in the previous post. I think I have it straight now.thumbs_up.gif Somebody jump out there and correct me if it looks fishy!

 

Assuming your activity is a hobby, you can only deduct hobby losses to the extent of hobby income (i.e. no net hobby losses, which is the point of the provision). 

 

Essentially, there are three potential limitations to hobby loss deductions applied in the following order. Get ready...cowboy.gif

 

Going back to the previous example and assuming it's a hobby...1,000 gross income on hobby cakes; 3,000 expenses on hobby cakes; 100,000 AGI

 

Test 1: The first number for "potentially deductible hobby losses" is the same amount of your gross income. That is, you cannot use an expense number larger than the gross sales number. So, 1000 of income; 1000 of expenses (Note: tossed by the wayside: 2,000 in expenses that will never see the light of deduction day...icon_eek.gif)

 

Test 2: I misspoke above...it is the 2% AGI test, not the 2.5% test. (Ignore the previous numbers as well ...my humble apologies. The numbers and order of applying the limitations were mixed up) ...So, since $1,000 of expenses fails to meets the 2% AGI test, none of the hobby losses are deductible. End Result: Report 1,000 as hobby income and zero expenses will offset...icon_cry.gif

 

Example Tweaked: 10,000 of hobby income, 10,000 of expenses. still 100,000 AGI. In test 2...10,000 of expenses exceeds the 2% floor, so 8,000 would be a miscellaneous itemized deduction....but that is subject to yet one more limitation...

 

 

Test 3:

 

Now, even if you meet those 2 tests, you still must itemize to get the benefit. In other words, if that 8,000 was the only itemized deduction you had, you would be better off to take the standard deduction, which in 2012 is $11,900 for married filers, that is assuming you are married...(comic relief in the midst of mumbo jumbo). (Other itemized deductions to lump with the hobby losses are property taxes, mortgage interest, etc.) Assuming you don't itemize, end result: 10,000 hobby income, ZERO expenses...sigh...

 

 Assuming you had other itemized deductions that would cause you to itemize, you would get to deduct $8,000 of hobby losses while also still showing 10,000 of hobby income.

 

 

Again, there are many factors to consider here--the most obvious being "are you continually reporting losses" and are you (in the IRS' eyes) "irrationally" continuing to do this "business" because you think "someday, somewhere over the rainbow" consumers will pay what the cakes are worth and allow you to turn a legitimate business profit that leads to a black bottom line. (Note: Start-up costs are a whole separate deal.)

 

In general, if your activity is posting losses as a business for a number of years, the IRS may argue that you are not engaged in an activity for profit and must report all gross income as hobby income; in most cases, you won't get the benefit of the hobby losses due to the three tests/limitations described above. In no case, however, will you be able to deduct a net hobby loss as you would a net business loss.

 

In my limited, and I emphasize limited, research related to how advertising affects this, it seems to just be one of many factors considered. If you have any questions, you need to take your specific situation to a C.P.A. who can look at your gross numbers, expenses, length of time doing this, and your overall situation (do you have a day job, how much time do you spend 'caking' etc.) to determine if the activity should be classified as a hobby.

 

None of this is intending to be professional advice; it's just food for thought from a bean counter that is just trying to survive grad school! It is information to help you to engage your CPA to make the correct legal determination for your situation. Please be proactive. Once you sign the return, you are validating the information and stance contained therein.

Jess155 Posted 27 Feb 2013 , 6:22am

I don't know much about the laws, but even if the IRS doesn't care, doesn't the Department of Ag?  It is a food item, not jewelry or something.  It could be hazardous.  And yes, I know people say "I keep my kitchen cleaner than any restaurant".  True as that may be, they have a legal license to sell food and insurance to stand on if something goes wrong. 

Suuske Posted 27 Feb 2013 , 8:30am

We have the exact same discussion at this moment in the Netherlands. We have similar regulations on what our taxauthorities define business vs hobby.

 

I personally believe that when you start to bake for complete strangers, and you bake more than 2 or 3 cakes per month and you profile yourself with a website and/or business FB page, the general public will perceive you as a business. When that happens you transcend from a hobby to a business, no matter what you tell yourself to justify your choices.

-K8memphis Posted 27 Feb 2013 , 2:26pm

all i'm saying is that the irs does allow for hobbyists in this quote

 

that the irs recognizes that a hobbyist does at times exchange money for product and therefore not illegally transacted

 

no debate no deductions no hornet's here just a tidbit of info on an isolated narrow distinction clearly stated in post #1

 

that imo in some cases hobbyists can receive money and it not be a business according to the irs quote

 

it's no problem if you interpret differently--no worries

 

peace out

 

jason_kraft Posted 27 Feb 2013 , 3:06pm

A

Original message sent by -K8memphis

that the irs recognizes that a hobbyist does at times exchange money for product and therefore not illegally transacted

Whether or not the transaction is legal is irrelevant according to the IRS. In fact there is a line on Form 1040 specifically for reporting income from illegal activities, including bribes, drug dealing, and stolen property (reported as fair market value in the year you steal it).

The IRS's treatment of hobby income is so disadvantageous, if you have any significant income from a hobby you are usually better off making it into a business.

kikiandkyle Posted 27 Feb 2013 , 3:33pm

The IRS doesn't set criminal laws, health codes or state licensing laws, it sets tax laws.

-K8memphis Posted 27 Feb 2013 , 3:44pm

i understand it is the reigning opinion that money exchanged for cake constitues a business

 

if we carry on with this discussion please quote/discuss the intent/spirit of my viewpoint clearly stated

 

hobbies exist and can transact money and not be a business according to this quote

 

where the irs boundaries reside is stated there fairly clearly and as such clearly open to individual interpretation

 

but imo the exchange of one dollar is not it

 

jason, i'm glad hobbies are not listed with the illegal activities--

NJsugarmama Posted 27 Feb 2013 , 3:54pm

ACan we agree that there is waaaaaay too much government?!? Seriously. We own 2 restaurants. We need a license to sell milk for crying out loud. The fine line between business and hobby is

NJsugarmama Posted 27 Feb 2013 , 3:57pm

Agrey. If someone asks me to make a cake, I'll do it...in my unlicensed kitchen. I ask them to pay for supplies/ingredients. No biggie. Do you all make sure your babysitters are licensed and declare their income?! Didn't think so.

JimmyBoombats Posted 27 Feb 2013 , 4:09pm

I would guess if there is no profit to be made and no charge for labor, it sounds like a hobby to me. Taking money for ingredients is not a profit.icon_cool.gif

 

Just sayin, Jimmy Boombats

jason_kraft Posted 27 Feb 2013 , 4:22pm

A

Original message sent by JimmyBoombats

I would guess if there is no profit to be made and no charge for labor, it sounds like a hobby to me. Taking money for ingredients is not a profit.8)

Agreed, but the IRS still taxes hobby income as if it was pure profit until you exceed the 2% AGI misc deductions threshold.

kikiandkyle Posted 27 Feb 2013 , 5:37pm

Has anyone actually ever sought a qualified legal opinion on whether taking money only for ingredients constitutes operating as a business or not (aside from what the IRS says about taxing any profits). Does it still depend on the county/state law for your area? Because all I can find is hearsay online. Some say its OK, some say not. 

jason_kraft Posted 27 Feb 2013 , 5:55pm

AThe definition of a business from the perspective of licensing and food safety typically centers around whether or not your business interacts with the general public.

So if you have a storefront, advertise, hand out business cards to the public, and/or have a business web site that is publicly available, you are generally considered a business. If you only make cakes on request from friends and family and do not advertise this to the general public (and you reject orders from outside your circle of friends and family) you would probably not be considered a business.

Of course this will vary depending on your city/county/state, both on the basis of different regulations and how those regulations are enforced.

AZCouture Posted 27 Feb 2013 , 6:04pm
Quote:
Originally Posted by jason_kraft 


Of course this will vary depending on your city/county/state, both on the basis of different regulations and how those regulations are enforced.

And that's the kicker right there. The IRS is not the end all of what constitutes a business.

FromScratchSF Posted 27 Feb 2013 , 6:07pm

I think the reason there is no real concrete answer is because no CPA (that I know of) is going to give blanket tax advice.  Everyone's situation is unique, not to mention every county and state has different laws about this.  All I can say is my sister is a very successful CPA in CA specializing in business taxation.  The first time someone offered me money to make a cake I picked up the phone and called her.  She told me...

 

"If you walk like a duck the IRS and the State of California are going to treat you like a duck, and so am I.  If you want to do this, here's what you need to do..."

 

Again, advice specific to me, my intentions and circumstances and YAY having a CPA in the family.  So if you want a real answer specific to you, you should call a CPA in your area.  And maybe your local business license office because my county considers any dollar changing hands as a business transaction.

kikiandkyle Posted 27 Feb 2013 , 6:21pm

I just contacted my state health department to ask about receiving reimbursement for expenses from friends and family so I'll report back if I get a response. 

jenmat Posted 27 Feb 2013 , 6:56pm

A lot of the time here on CC the question of business vrs hobby comes up during one of 2 posts

1. Help! I made a cake for xxxx and she hated it and wants her money back, what should I do?

or 

2. Help! I just got my first order and have no idea what to charge!

 

Tax and law aside, someone who is paying for a cake certainly considers themselves a customer and usually acts as such, no matter how much you feel you are a hobbyist and do not want to deal with business-y type things like complaints, policies, and pricing structures. If you are doing the cake for free (no money at all), then the recipient usually does not behave like a customer and you don't have to deal with business-y things. 

 

I have NO problem with people doing cakes for a hobby, even accepting some money for supplies- I get it. But don't be surprised when the person asking for the cake and writing the check acts like a customer- because when they pay you, they are.  

Godot Posted 27 Feb 2013 , 7:01pm

jenmat - you forgot number three: Help! I've taken the first Wilton class and I have now started my business and taken my first order. Can someone tell me what to charge and give me recipes?

gatorcake Posted 27 Feb 2013 , 7:22pm
Quote:
Originally Posted by AZCouture 

And that's the kicker right there. The IRS is not the end all of what constitutes a business.

 

Has anyone claimed this?   Certainly not the original post which specifically addresses a common response given to people here when they mention they accept money for ingredients as a hobbyist only to be told they are operating a business BECAUSE they accepted that money.  There is a thread in this forum about two weeks old where this activity is precisely what the person describes only to be told in the first post they are not a hobbyist they are a business.  There is no mention of food or safety issues in the reply characterizing this activity as a business activity--it only mentions the payment for ingredients.

 

In addition, a search of this site reveals posts where individuals say I know as a hobbyist I cannot accept any money, even for ingredients, because I would be running a business.  Again these statements have nothing to do with issues other than the accepting of money too cover costs of their hobby.  There have also been a variety of threads discussing whether or not accepting funds can be counted as a donation.  Again the discussion centered on the question of the receiving of money for an item, not other concerns raised here in terms of what counts as a business.  

 

The page cited is more than a simple a "tax page," it is the criteria used by the IRS to ascertain whether an activity counts as a hobby or a business.  The original post uses this because it specifically addresses a belief that is (despite Jason's claim that most center on questions of advertising to the general public) routinely expressed on these boards often to curtail the actions of hobbyists.  It specifically addresses the claim: you take money, you are a business and not a hobby.  An activity can in fact generate income and not be consider a business activity.  Whether other laws or agencies would consider selling a cake a business from a safety or health standpoint is irrelevant to the question raised by a hobbyist who wants to know whether taking money from a friend for ingredients makes them an illegal business from the stand point of receiving money to cover some of the costs of their hobby.  So yeah it makes clear that hobbyists in fact are not walking like ducks from the perspective of the IRS if they generate income (income does not equal profit) by asking others to cover the costs of the cake they make.  

jason_kraft Posted 27 Feb 2013 , 7:36pm

A

Original message sent by gatorcake

The original post uses this because it specifically addresses a belief that is (despite Jason's claim that most center on questions of advertising to the general public) routinely expressed on these boards often to curtail the actions of hobbyists.

I actually found that definition (interaction with public = business) very recently while researching this topic, IMO it eloquently make a distinction that can be used as a rule of a thumb.

I was never a huge fan of the "accepting money = business" definition, since it means that you are running a business if a family member reimburses you for a cake, and even if that is technically true (I'm not sure that it is) realistically there would be no way of anyone else knowing unless you advertise it publicly.

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