Matt is single, age 25 and has salary from his job as a sports announcer in the
ID: 2577966 • Letter: M
Question
Matt is single, age 25 and has salary from his job as a sports announcer in the amount of $50,000. Matt also has the following income and expenses related to an activity:
Income- $23,000
Mortgage interest- from his home office- $8,000
Property taxes- from his home office- $2,000
Depreciation- $5,000
Supplies and fees- $8,000
Telephone- $2,000
1. Briefly define an activity classified as a hobby vs. a business?
2. List 4 factors might be used to assist a taxpayer in determining whether an activity is a hobby or a business?
3. If a hobby, answer the following questions:
a. Are hobby expenses deductions FOR AGI or FROM AGI?
b. What form/schedule and line is hobby income reported on?
c. What form/schedule and line are hobby expenses reported on?
d. Calculate Matt's AGI.
e. What is the rule regarding how hobby expenses are deducted, including the ordering of expenses and all limitations?
f. Apply the rule in (e) above and prepare a detailed schedule of your calculation of deductible hobby expenses are calculated.
4. If a business, answer the following questions:
a. Are business expense deductions FOR AGI or FROM AGI?
b. What form/schedule is business income reported on?
c. What form/schedule are business expenses reported on?
d. Prepare a tax return for Matt, assuming he uses the standard deduction and has no dependents.
Explanation / Answer
1. As per the IRS, an activity performed by a person becomes his hobby when he does not perform such activity for the purpose of making the profit i.e he is not trying to earn money from that activity. If an activity is considered as a hobby then the expenses related to such activity are deductible only till the amount of income earned from the hobby activity. Moreover, any losses from hobby activity may not be used to offset other income. However, on the other side if such activity is performed with sole intention of earning money then such activity falls under the category of Business as per the IRS.
2. Four factors for guiding whether any activity is hobby or business are as follows:
a. Does the time and effort put into the activity indicate an intention to make a profit?
b. Does the taxpayer depend on income from the activity?
c. Does the activity make a profit in some years?
d. Has the taxpayer changed methods of operation to improve profitability?
3. a. If the IRS declares it’s a hobby, you can’t deduct business losses and expenses on your tax return. You can only deduct your hobby expenses up to the amount of income you earn. Therefore, expenses are not wholly deductible from AGI but deductible only till the amount of income earned from hobby.
b. Hobby income is reported on Form 1040, Line 21.
c. Deductions for hobby activities are claimed as itemized deductions on Schedule A (Form 1040).
e. Rule regarding hobby expenses- Hobby expenses are taken in the below mentioned order only:
1. Home mortgage interest and taxes for personal as well as business activities may be taken in full.
2. Advertising, insurance premiums and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category. These are those deductions that don’t result in an adjustment to basis.
3. Business deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.