Converting Sch C to Hobby

[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.

[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.

[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.

[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.

[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.

[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).

[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.

[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%.

[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.

[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.

[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.

[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

[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.

[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.

[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.