Newsletter - February 11, 2009

The Jewelry Crafter

A newsletter for the home jeweler

This newsletter will be published every 2 weeks, and will include hints and tips for your jewelry business. Any feedback or comments about the topics presented here are always appreciated. Click here to e-mail us.

If you have an idea for an upcoming article, or would like to submit an article for the newsletter, please contact us. Anyone who submits an article will receive a permanent link to their website in a special section of our link pages.

Hobby or Business?

By

Mary Harvey

Most people begin their jewelry-making career as a labor of love. They enjoy the challenge and the rewards of creating a one-of-a-kind piece of jewelry. Some sell their pieces and make a profit. But how do you know if your jewelry making is a hobby or a business?  What are the advantages and disadvantages of being a business versus a hobby? In this issue, we will explore the IRS definition of business, and how to determine which applies to you.

The IRS defines a hobby as an activity that you engage in without expecting to make a taxable profit. If you make, or intend to make, a profit, the IRS considers you a business. As a business, you are able to deduct expenses directly from your income, where as a hobby, you are not. 

A business is allowed to operate at a loss. The IRS has what is called the “hobby loss rule”, or the “3 of 5” rule. You must show that you either made or intended to make a profit in the last 3 of 5 years. If you do not, your activity is considered a hobby, and you cannot deduct your losses from your income. 

The IRS takes several factors into account when determining if your activity is for profit:

• You carry on the activity in a business-like manner
• The time and effort you put into the activity indicate you intend to make it profitable
• You depend on income from the activity for you livlihood
• Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your business)
• You change your methods of operation in an attempt to improve profitability
• You have the knowledge needed to carry on the activity as a successful business
• You were successful in making a profit in similar activities in the past
• The activity makes a profit in some years and the amount of profit it makes
• You expect to make a future profit from the appreciation of the assets used in the activity

Consecutive year losses (the hobby loss rule), is a huge red flag to the IRS, and can trigger an audit. If this happens, you must be able to show the IRS that you are making an attempt to run a legitimate business, and not just trying to claim business tax breaks. The best way to prove this is to run your business like a business – a well maintained set of books (separate from your personal finances), proper business licenses, business cards and letterhead, advertising or other marketing efforts can help persuade the IRS that you are a legitimate business.

It is very important if you are thinking of starting a business, or converting a hobby into a business, that you consult a professional. An accountant, financial planner or business coach will know the current rules, and can save you a lot of headaches down the road. 

For more information on setting up your business, see the IRS Website at www.irs.gov, or the Small Business Administration at www.sba.gov, your local SCORE chapter, www.score.org.

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