March 3, 2010 12:00 am

Candle-Making Activity Was a Hobby

In today’s tough economy, many people are looking to sideline activities to supplement their income. Unfortunately, unless you do things right, expenses related to the sideline activity won’t be deductible.

The following is a cautionary tale for anyone who wants to pursue a sideline business. In a recent case, a nurse made and sold candles on the side. In one year, she reported income from this activity on Schedule C of $2,351 and expenses of $33,475. The expenses were for advertising, insurance, taxes, licenses, travel, utilities, and other items, and she was able to substantiate these amounts. The IRS disallowed her deductions on the grounds that she was not running a business but merely did candle-making as a hobby.

The Tax Court agreed with the IRS because of these factors:

  • She did not maintain a general ledger or financial statements.
  • She did not have records of insurance, records of appraisal, or records of advertising.
  • She did not use a separate bank account relating to her retail activity (expenses relating to petitioner’s retail activity were billed to her and paid out of her personal accounts).
  • She did not create business or marketing plans, operating budgets, cost-benefit analyses, or financial projections relating to the activity.
  • She did not obtain a business license or fictitious business name relating to her retail activity.

When deductions are disallowed as business write-offs, they can be claimed to the extent of hobby income as a miscellaneous itemized deduction on Schedule A of Form 1040. The balance of the deductions for the year is lost; the excess cannot be carried forward and used in a subsequent year.

Source: Georgia C. Farber v. Commissioner; T.C. Memo. 2010-37

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Tax Glossary

Assessment

The IRS action of fixing tax liability that sets in motion collection procedures, such as charging interest, imposing penalties, and, if necessary, seizing property.

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