Just because you sell online doesn't mean you are a business in the eyes of the IRS, as a seller of sports memorabilia discovered. And if your ecommerce business doesn't stand up to IRS scrutiny, it could be costly, especially in light of a change included in the new tax bill which affects sellers for the 2018 tax year.
Tony Nitti's December 9th column
in Forbes focused our attention on the issue. He's a master at making taxes interesting (the Tony Bourdain of taxes), and the cases he described in this piece are eye-opening.
The column referred to a 2014 case that's especially worthy of review in light of the new tax law. The IRS found that a taxpayer (Akey) operated his sports memorabilia business as a hobby rather than a profit-driven business - therefore, could not necessarily expense all of his costs. (Until this year, you could deduct hobby expenses, but only up to the amount of your hobby income.)
How does the IRS determine a "business" is actually a "hobby"?
Nitti listed nine factors. For example, the first factor is, "The manner in which the taxpayer carries on the activity." Nitti's take: "Does the taxpayer complete accurate books? Were records used to improve performance?"
Nitti provided context by comparing the practices of the owner of the sports memorabilia business (Akey) who lost his case to another taxpayer Crile, who was successful in arguing her case in tax court. The comparison is helpful in understanding what the IRS is looking for when determining whether your activities are a business or a hobby - and can help you make changes if needed.
For example, Nitti wrote:
"In Akey, the taxpayer did nothing to acquire expertise in baseball card collecting aside from purchasing price guides, which as the court pointed out, is pretty much the one mandatory acquisition for anyone interested in buying and selling cards, even if it were merely as a hobby. As a result, this purchase did nothing to differentiate his activity as a business.
"While not everyone can achieve the level of success enjoyed by Crile, the taxpayer in Akey could have established that he routinely attended trade shows, conducted sophisticated research, and consulted with industry experts about buying and selling tactics to bolster his argument that his activity was a business."
Nitti writes about other cases, one in which the ninth factor played a role: "Does the activity lack elements of personal pleasure or recreation?" Yes, the IRS actually takes into consideration whether a taxpayer enjoys what they're doing to help determine if they run a business or a hobby!
So where does the new Tax Cuts and Jobs Act come into play?
Nitti explains that the ramifications of being categorized as a hobby are severe, summing up: "from 2017 on, if you're conducting a hobby, and not a business, you have to include all of the income, but can't deduct any of the expenses. Ouch."
In this MarketWatch article
titled, "You can't deduct hobby-related expenses under the new tax law - but don't give up hope," the author expresses a similar reaction: "So under the new law, you cannot deduct any hobby-related expenses, but you still must report 100% of any revenue from the hobby activity as income and pay tax on it. Yikes!"
The author went on to say that he expects IRS auditors to focus even more attention on individuals with money-losing sideline activities.
It's absolutely imperative that you conduct your activity in a businesslike manner, Nitti says - and it's not enough to simply keep a Quickbooks account. He ends his column with some concrete advice.
Our advice: add this article
to your list of end-of-year tax planning activities.