Converting Sch C to Hobby

[Gary2]

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.

I assumed they were issued by Nu Skin (or whatever the parent company is called), for the payment of commissions. Often in these businesses, the sales rep takes the order, forwards the payment or credit card info to the vendor who ships the product, and gets paid strictly on a commission basis.

However, while I agree with the essence of your argument, there is a limit, which is why the hobby versus business test has so many facets. Suppose someone who fixes up antique cars as a hobby sees an auto shop or body shop going out of business, and buys it at fire sale prices. Then, because this person was more interested in having extra space and some hydraulic lifts, continues to operate it as a hobby, say by stopping all advertising except for the existing signs, quoting ten week turnaround times to every customer except for friends and relatives, yet three or four unrelated people a year are crazy enough to use his services, because his reputation is great and his prices low - so low that he barely breaks even on the strangers, before overhead. Business or hobby?

You can fight the 3 of 5 rule, but you'd better be prepared to show a legitimate strategy and corresponding effort for making a profit sooner or later.

[Roland Slugg]

When someone with the credentials of his eminence Bees Knees not only disagrees with me but disagrees "strongly," I believe a further posting is in order.

Before deciding how to handle his client's Nu Skin "activity" the person who started this thread (or anyone with a similar client situation) would be well advised to read Regs §1.183-2, "Activity not engaged in for profit defined." That Reg (in which the term "hobby" is used at least one time) contains a great deal of interesting and useful information about the subject.

A thorough reading of that Reg, along with first-hand knowledge of the T/P's Nu Skin activities, as well as his other tax, income and financial "profile," should put the preparer in a good position to inform his client intelligently.

Btw, the "3-out-of-5-years presumption" is a rebuttable presumption. The reverse is also true, namely that profits in 3 out of 5 years is no guarantee that the IRS will concede that an activity is a for-profit one. Three years of tiny profits mixed in with two years of big losses won't cut it in the long run if other facts point to a not-for-profit conclusion.

Before ending this post, I feel compelled to add this: In almost every thread of any length there is often at least one person who replies with a completely fabricated set of esoteric possibilities crafted, I suppose, to make some contrary point. I'm referring in this case to the comments about the classic car enthusiast who buys an auto repair shop then makes no effort to run it profitably. I regard posts like that as just plain silly, serving no useful purpose whatsoever. I take it for granted that people who post here ... especially first-timers ... pose questions because they want and need legitimate and sincere help with a concern affecting them or one of their clients. I, for one, try to do that every time I post here, and so do most others. I wish everyone would.

[Jesse]

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.

I think you need to look at the facts and circumstances of every individual situation. Often direct sale companies, Partylite, Avon, Pampered Chef, etc...., use "and you can write off everything" as a recruiting tactic. For example, one company rep in our area explains to the recruits to sell the products at work and then you can deduct all of your miles to and from work, (because you are delivering products to customers that just happen to be where you work), you can deduct your home expenses if you have an office or store inventory, and the list goes on. Fun/pleasure/enjoyment for the most part does not even enter the picture nor does the goal of making money -it's mostly for the avoidance of tax. If I do happen to make some money yeah for me because all the deductions, going to work and maintaining my home I would have with or without my "business".

On the flip side, there are some that genuinely believe they will make some money, and those that actually do make money. Again facts and circumstances of each individual case need to be looked at.

[Gary2]

When someone with the credentials of his eminence ...
... pose questions because they want and need legitimate and sincere help with a concern affecting them or one of their clients. I, for one, try to do that every time I post here, and so do most others. I wish everyone would.

I agree with almost all of this post, except for the obvious complaint.

The use of contrived examples is a pedagogical device that works for many people, but not everyone. Reasoning by analogy can certainly be abused, and is always at risk of being flawed. But I'll go as far as saying that the IRC has many cases of subtle rules and requirements that can best be explained by contrived examples (e.g., the "twin paradox").

I'm sorry if that type of example doesn't work for you. And sometimes, they do fall flat, working for no one. Even Bob Hope (or Jerry Seinfeld, for you younger folks) would sometimes tell a dud. But I disagree that they're never helpful. And I most certainly do try to be helpful here.

[Burke]

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.

And neither have I, having done this a multitude of times.