Converting Sch C to Hobby

[TaxTime829]

Client operating a Nu Skin business for 4 years... never made profit... no future profit expected at this time.
I need to convert the Sch C business to a Hobby this year.
Questions:
1. Client receives a 1099... How do I report the 1099 in the tax return... Doesn't the 1099 need to be reported as a business?
2. The Sch C had a depreciation schedule... Do I need to recapture the depreciation?
3. How do I report COGS... Read most of the stuff on IRS.gov... they don't mention deducting COGS on line 21... Has anyone put COGS on the Sch A?

[veritas]

See an excellent example

Client operating a Nu Skin business for 4 years... never made profit... no future profit expected at this time.
I need to convert the Sch C business to a Hobby this year.
Questions:
1. Client receives a 1099... How do I report the 1099 in the tax return... Doesn't the 1099 need to be reported as a business?
2. The Sch C had a depreciation schedule... Do I need to recapture the depreciation?
3. How do I report COGS... Read most of the stuff on IRS.gov... they don't mention deducting COGS on line 21... Has anyone put COGS on the Sch A?

on pg 5-21 in TTB.

[Gary2]

1. People issuing the 1099-MISC (box 7), particularly under the new rules (and rumored rules), often don't have enough information to determine whether or not the activity is a business or hobby. So there is no rigid rule saying that it must be reported on a Schedule C. However, failure to do so is likely to generate a CP2000 or other letter. There are various tactics to head off the automatic letters, but I'll withhold commenting due to insufficient experience with them.

2. Off the top of my head, you must recapture anything that would ordinarily have to be recaptured if it's subject to the minimum 50% business use rule. But run of the mill depreciation only needs to be recaptured when sold.

3. COGS is factored into the line 21 amount, since it is considered a return of capital. I don't have any citations handy, but I'm pretty sure there's case law to back this up. There was a recent case in which a medical marijuana business in CA was allowed COGS but not other business expenses, under the law prohibiting the deduction of business expenses for trafficking in controlled substances. This case isn't directly on point (since there was no question about the activity being a business), but illustrates the different treatment of COGS.

Or look at it this way: Person A makes silver jewelry as a hobby, and B makes gold jewelry, also hobby, each charging just enough to cover their costs, including tools, etc. They both sell a half dozen pieces a year, A for about $300 gross and B for about $3000 gross, due entirely to the difference in price between silver and gold, but both with a net of +/- $50. You wouldn't expect or want B to be paying ten times as much in taxes, for the same work, simply because of their choice of raw material.

[Kram BergGold]

How to report 1099

If the amount is reported in box 7 then report the amount on Schedule C and take a corresponding deduction called income from a hobby moving to Form 1040 line 21.

[Bees Knees]

Just because box 7 of a 1099 reports income does not mean a Schedule C must be filed. IRS should be able to match that to something reported on line 21 of the 1040. I would put the amount directly on line 21 (net of cost of goods sold). If IRS issues a CP2000, tell them the amount is on line 21, as it is required to be for hobbies.

[Kram BergGold]

Disagree wiht Bees

The IRS wil issue the CP2000 and now you have to deal with it. My way there is no fuss or muss.
Why not avoid a problem instead of creating one.

[kpangelinan]

If the amount is reported in box 7 then report the amount on Schedule C and take a corresponding deduction called income from a hobby moving to Form 1040 line 21.

Ditto here.

Just because box 7 of a 1099 reports income does not mean a Schedule C must be filed. IRS should be able to match that to something reported on line 21 of the 1040. I would put the amount directly on line 21 (net of cost of goods sold). If IRS issues a CP2000, tell them the amount is on line 21, as it is required to be for hobbies.

Nope.

The IRS wil issue the CP2000 and now you have to deal with it. My way there is no fuss or muss.
Why not avoid a problem instead of creating one.

This would have been my thoughts as well even before I read your post and have done it several times.

[Jesse]

The IRS wil issue the CP2000 and now you have to deal with it. My way there is no fuss or muss.
Why not avoid a problem instead of creating one.

I agree too, if at any time a 1099MISC w/ amount in box 7 is issued but not subject to the Schedule C and SE tax I always do a "dummy" schedule C with the amount subtracted and netted to $-0-. In my opinion it's just so much easier to avoid the CP2000.

[oceanlovin'ea]

My question to you would be if you are wanting to convert to a hobby only because she has shown no profit. Some people are running these as a business and trying to make a go of it. But some of them take longer than others. The direct sales businesses are known for this.

So I would first figure out what her purpose in being in the Nu Skin business is. Is it just that she wants something to do? Is she trying to make some money at it? Or is she in it only to be able to buy the product for herself?

If they send her a 1099 and she is only buying product for herself, then she shouldn't have to pay taxes on that money. It isn't income. She is just buying at a discount.

Linda, EA

[Bees Knees]

I agree too, if at any time a 1099MISC w/ amount in box 7 is issued but not subject to the Schedule C and SE tax I always do a "dummy" schedule C with the amount subtracted and netted to $-0-. In my opinion it's just so much easier to avoid the CP2000.

Box 7 of 1099-MISC says:

If you are not an employee but the
amount in this box is not SE income (for example, it is income from a sporadic
activity or a hobby), report it on Form 1040, line 21 (or Form 1040NR, line 21).

You are actually not following IRS instructions when you put it first on the Schedule C.

IRS does NOT automatically issue a CP2000 when box 7 does not appear on a Schedule C. I report box 7 amounts on line 21 of the 1040 when it is not subject to SE tax. I identify the 1099-MISC and issuing EIN number on the explanation line next to line 21 of the 1040. I have NEVER received a CP2000 when doing it this way.

[Jesse]

Box 7 of 1099-MISC says:



You are actually not following IRS instructions when you put it first on the Schedule C.

IRS does NOT automatically issue a CP2000 when box 7 does not appear on a Schedule C. I report box 7 amounts on line 21 of the 1040 when it is not subject to SE tax. I identify the 1099-MISC and issuing EIN number on the explanation line next to line 21 of the 1040. I have NEVER received a CP2000 when doing it this way.

Quite a few years ago we had a logger in our neck of the woods that issued the 1099-MISC w/amount in box 7 for timber harvested, when a 1099-S should have been the correct form to issue. After responding to a few CP2000 letters I decided to do the "dummy" schedule C. Also once had a radio station that reported a prize in box 7 when it should have been box 3, a CP2000 wasn't issued, but a letter and forms requesting taxpayer double check to make sure the income was not subject to self employment tax. If so, possible schedule C income so taxpayer should correct, if not do nothing.

It doesn't happen often that the 1099-Misc is incorrectly issued with the amount in box 7, but when it comes across my desk I'm going to continue to do the "dummy" schedule C. With enough to worry about I'm not going to loose any sleep about not following the instructions in this case, the $$ amount of tax liability will still be the same.

[Roland Slugg]

I would like to offer a completely different perspective on the OP.

A "hobby" is an activity that most people engage in for fun/pleasure/enjoyment and a few people engage in with the HOPE of making money, of which some actually do make a profit ... at least some of the time. The most common example, often cited by the IRS itself, is horse racing. I would say any kind of vehicle racing would also fit the definition of a "hobby" that a few people also make a profit doing.

But would anybody own and operate a gas station as a hobby? An office supply store? A laundromat? A Nu Skin franchise? I don't think so. So if someone does operate a business that couldn't conceivably be alleged to be a hobby in disguise, then the fact that it loses money becomes a moot point. Legitimate losses incurred in a trade or business are deductible, subject, of course, to adherence to all the rules and limitations. In the case of the Nu Skin business, as long as personal use inventory is backed out, along with all personal expenses, and there is still a loss, then it's deductible.

I'm also puzzled about that 1099-MISC form. Form 1099-MISC doesn't need to be issued to report the purchase of goods ... just payments for services (and rents and a few other special payment categories). Also, forms 1099-MISC are only issued by businesses, not by individuals. So I'm wondering why the T/P is receiving forms 1099-MISC at all, even if he is selling some of his Nu Skin products to businesses.

If this were my client, I would continue to deduct his losses on Schedule C as long as they occurred, advising him, of course, to make sure his deducted expenses were all legitimate business expenses ... eliminating everything personal. Depending on the amounts of those losses, they could, of course, serve as an audit trigger.

[TaxTime829]

A dummy Sch C doesn't make it a hobby.

If the amount is reported in box 7 then report the amount on Schedule C and take a corresponding deduction called income from a hobby moving to Form 1040 line 21.

Ok... I believe clients come to tax professionals to file returns with as few problems as possible... with that said I like the "idea" of using a dummy Sch C because it stops the CP2000.

I don't like the fact that the business goes on... making $0 income forever...

The whole question is how to stop the business (Sch C) and make it a hobby.

This doesn't seem to stop the business at all.

TheTaxBook says to put revenue less COGS on line 21... but I'm sure that would generate a CP2000 and all the client issues that come with it because the amount doesn't match the 1099-Misc.

It seems the best approach is to put the Line 7 amount from the 1099-Misc directly on line 21... then deduct COGS along with other expenses on the Sch A subject to the 2%.

[Bees Knees]

A "hobby" is an activity that most people engage in for fun/pleasure/enjoyment and a few people engage in with the HOPE of making money, of which some actually do make a profit ... at least some of the time. But would anybody own and operate a gas station as a hobby? An office supply store? A laundromat? A Nu Skin franchise? I don't think so. So if someone does operate a business that couldn't conceivably be alleged to be a hobby in disguise, then the fact that it loses money becomes a moot point.

Oh, I disagree strongly. Section 183 says nothing about it having to be a hobby for the rules to apply. The code section doesn't even use the term hobby. Section 183 is titled: "Activities not engaged in for profit." That means the rules apply regardless of whether the taxpayer is doing it for fun. There are all kinds of reasons, other than as a hobby, why Nu Skin, or Avon, or Mary Kay, or Pampered Chief people do what they do. A big factor is it is a way for them to personally buy the products at a discount. Sell pots and pans as a Pampered Chief rep and be able to get your favorite onion peeler for half price. Is that a hobby? No. But it is an activity not engaged in for profit. Thus, Section 183 still applies.

[Bees Knees]

It seems the best approach is to put the Line 7 amount from the 1099-Misc directly on line 21... then deduct COGS along with other expenses on the Sch A subject to the 2%.

COGS are deductible on line 21 of Form 1040 and do not have to go on Schdule A subject to the 2% AGI limit. See Reg. §1.183-1(e).