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axpayers whose expenses are considered hobby expenses may not claim a loss from that activity, although they may deduct the expenses against income from that hobby. Conversely, business expenses may be deducted fully from business income, generate a loss, and offset the taxpayer’s ordinary income. These differences, among several others, require that the tax preparer have a clear understanding of all the facts and circumstances to determine whether a client’s activity is a trade or business, or a hobby.
The second article will explore the deductibility of certain expenses that are commonly presented by taxpayers as business expenses, such as travel, special clothing, and research expenses. Even after the tax preparer is confident about the classification of a client’s activity, the deductibility of certain expenses may be difficult for the tax preparer to determine without understanding the facts and circumstances surrounding the expense.
A client conversation
John Keats, your new client, shows up for his first appointment carrying a ream of papers, receipts, and last year’s tax return (prepared by his brother-in-law, a physical therapist). John is getting more work for his freelance writing business, and he believes he should have a professional tax preparer complete and file his tax return.
After an introductory conversation with John and a quick review of his documents, you learn that John works full-time as a public relations professional at a large corporation. He earned a salary of $83,000 in 2009.
You notice an entry for $800 on Form 1040, Line 21. John explained that the income was for writing an article that was purchased by a local magazine publisher. The publisher loved the article and encouraged John to submit more work. John wanted to do more freelance writing for the extra money, as well as a possible new career if his corporate employer continued with its downsizing. John’s article was a travel article about bicycling in California.
You asked John whether he had any other income from his freelancing activities, which he did not. He replied that his brother-in-law didn’t even want to report the freelancing income at all because John was not a professional writer. However, John thought it should be reported, but he allowed his brother-in-law to record it on the other income line because, according to John, “That’s what it was – other income.” You also asked about expenses that might have gone along with the freelance income. John thought for a moment and then replied he didn’t think he had any in 2009, when he wrote his article.
Encouraged by this quick success and the publisher’s encouragement, John submitted more articles in 2010, as well as to other publishers with larger circulation. Several of his submissions were accepted, and for 2010, John earned $14,500 for his freelance work in addition to his full-time corporate salary.
In 2010, John described several expenses that he incurred related to his freelance writing, such as membership fees to a bicycle club, bicycling trips to Colorado and other locations, and a new computer. He also bought a new bike ($6,500) because it was related to his freelancing activity and would allow him to write articles (and maybe a book!) about his bicycling experiences, while earning income.
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