Pleas help ASAP Sara is a history professor at UCONN and is your new tax client.
ID: 2597598 • Letter: P
Question
Pleas help ASAP
Sara is a history professor at UCONN and is your new tax client. Sara started a hobby that she works on during her spare time during winter break, summer and on weekends. After taking a non-credit class at the Creative Arts Workshop in New Haven, she started making mosaic covered flower planters for outside gardens using materials such as Swarovski crystals, shards of glass and pottery found along the sides of rivers in Maine and terra cotta planters. Her AGI for 2017 before even considering her mosaic hobby is $120,000. During 2017, Sara made and sold 4 planters for a total of $12,000 at various Fine Arts Shows. While Sara was happy with how much money she made in her hobby, she did incur expenses for her hobby that are listed below:
$6,000
500
6,500
Making planters is really a hobby for Sara but she asks you to please briefly discuss how she must report these 4 items above (income, supplies, interest, advertising) on her personal tax return. Sara is not sure if she should include $12,000 in income, deduct $13,000 or a portion of it as expense before AGI, deduct $13,000 or a portion of it as an itemized deduction, deduct a portion for AGI and a portion from AGI, forget about the income because it is not more than 10% of her regular income, or some other way on her tax return.
Briefly discuss how Sara must report these items from her hobby on her personal tax return - 1.) income, 2.) supplies, 3.) interest, 4.) advertising
Crystals, grout and terra cotta planters (supplies)$6,000
Interest on bank loan to help Sara start her hobby/business500
Fine Arts Show publication advertising6,500
Explanation / Answer
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.
1. Hobby Income - Income of $12,000 earned by Sara is required to be reported by her on Form 1040, Line 21 as income.
Deductions for hobby expenses are claimed as itemized deductions on Schedule A (Form 1040). Moreover as per IRS, the same can be claimed upto the amount of income from such hobby. Hobby expenses can be taken in the below mentioned order only:
a. Home mortgage interest and taxes for personal as well as business activities may be taken in full.
b. 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.
c. 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.
2. Supplies - As per above given order, expenses on supplies are not deductible as itemized deductions by the Sara from hobby income. The same will not be reported in her personal income tax return.
3. Interest on bank loan- As per the above given order, interest expense on mortgage for starting the hobby can be claimed in full upto the amount of hobby income. In the given case, Sara is required to take $500 itemized deduction for the Interest on bank loan.
4. Advertising - As per the order, Advertising cost can be deducted after deduction of interest on bank loan but upto the amount of hooby income remaning, if any after set off of interest on loan. In the given case, whole $6,500 of advertising cost can be claimed as deduction.