Hobby shop Business? Is it worth doing?

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22
So I have another question.....Some people have asked me why I don't do a hobby shop business out of it. They say "You should make money off your hobby". I am wondering if anybody has done this? I know you can then do business tax write offs and I have had lots of people ask me to make things for them but what kind of profit is the IRS looking for? I know you cannot have losses every year but are they expecting you to show lots of profit? Or if I show a $100 profit a year will they leave you alone? Or will they say that it really isn't a business? Any of you do this?
I do not plan on making a living from doing wood projects but can I make a little and call it a business?
Any Food for thought?
Mike
 
This comes up from time to time and there are plethora of answers, many of them conflicting. You would be way ahead by talking with a tax preparer who does Schedule C's for small businesses. Especially ask and get answers concerning how the IRS responds to small businesses. Incidental income from a hobby is taxed as ordinary income and business income has entirely different parameters. A professional can tell you for sure where the lines are divided.

I have been been filing Schedule C's for over thirty years and every year it is something different. I now have a pro do it. If the IRS has a question, they have to defend their position. You, however, are still liable for the taxes, mistakes or no, or rulings that goes against you. I consider the few hundred dollars this costs me as the cost of doing business and that expense is also tax deductible. Understand the bookkeeping records are considerable.

And one more thing. Its not the tax owed. Its the fines they levy plus the uber-mafia interest rate that is retroactive to the date they determine you were not in compliance. In other words, its an all-in or don't dabble in the waters.

Example: A disallowed expense resulted in additional tax owed of $7.16. However, the fine and interest resulted in a tax bill of $111.00. Further, the cost of defending myself started at 5 times that amount with no guarantee of winning my position. I gulped and wrote the check.

Sorry for the bucket of cold water, but really do talk with a professional with experience in this area. Here you will get stories of guys who have been doing certain things for years with no issue. But what they have been doing will have no bearing on your activities or the defense of them.
 
Carol's response covers the issue quite well. You did ask
They say "You should make money off your hobby". I am wondering if anybody has done this?

Answer is 'yes'. In fact many small businesses are started as the result of a hobby. But to go all in is a risky proposition. The IRS wants you to show your hobby/business is your main source of livelihood or it is not a business and nothing is deductible. Some people handle their 'hobby' off the books. Remember, the IRS is not your friend.
 
well, here goes. after several years of running a "small business that pays (or attempts to) for the hobby, this is my experience. first of all, i needed to get a tax id for the state of minnesota, to do business at craft shows (one of them requires that one has a tax id). now that i have upgraded it to a L.L.C., now it is a legal corporation. as far as the irs goes, they have never asked whether or not it is the main source of livelihood at any time. i usually add (and a lot of people do this) the income from craft shows, and etsy, into my day job income, and pay the taxes that way, without a problem. i do have to fill out a separate form showing the value of any inventory, purchases for the company, and any losses for the year. along with the state and federal income taxes, in minnesota we have what we call sales and use taxes. the sales taxes are for businesses, and the use tax covers purchases (say, from grizzly), where there is no sales tax paid at the time of purchase, and one pays a use tax to the state, to cover the sales tax. i have to file that separately from the income taxes. the irs doesn't look for you to turn a profit, that is your responsibility as the maker/seller. they are only interested in your net sales, for tax purposes, and your state is interested in income and sales tax areas based on your sales. a lot of small businesses operate at a loss, until things get rolling. my first couple of years of doing craft shows were a net loss (not enough sales to cover the cost of space/table). the irs doesn't care if you have a profit or loss, they are just interested in the income that can be taxed. whether or not you are a legal business entity is covered by your state's secretary of state. as i said before, for the craft shows, i had to have a tax id. filed for the tax id, and voila!, i have a new business! all legal and happy. now that i've filed as a L.L.C., i've become legally separated from my company. someone could go after the company, but not me personally. a bit wordy, but that is my experience.
 
For more information on Dan's situation, read this for reporting requirements and options: https://www.irs.gov/businesses/smal...yed/single-member-limited-liability-companies.

I am going to explore this option in my state. And then I will likely follow the advise of my tax preparer.

And I can't argue with Frank about the 'friendliness' of the IRS. However they do have a mountain of information available, so ignorance is never a viable defense of innocence. The fact that you usually need an interpreter of that information is another issue!
 
I looked briefly at it, but the catch where I was wasn't the tax issue, it was the other regulatory problems and costs.

Check the local codes and regulations in your area carefully. In my specific location home occupations are problematic because you have to get a conditional use permit ($$'s) that can be pulled at any time if any one complains for any reason and requires everyone within some hundreds of feet (I think it worked out to my 12+- closest neighbours) being notified and any one of them having a chance to shoot it down ahead of time. So there was a significant uncertainty factor up front.

Additionally talk to your insurance agent, I discussed it with mine and as long as I don't sell anything ever its a hobby and my tools are all covered under my house insurance. IF otoh I start selling things and I didn't get an additional rider a) none of my tools would be covered and b) if there was a problem (fire, etc..) that originated in the garage that spread to the house it could also have caused my house coverage forfeit. The rider was something just north of $100/mo (about $1500/year if I remember correctly - I also recall it being quite a bit higher for woodworking than some other craft type industries) but I'm sure every insurance company classifies it differently (and probably by region) so check on what your specific situation is, it may well be a lot better.

Obviously all of this varies widely by region and coverage, etc.. so your mileage will most definitely vary from mine. In my case once I added it all up it was pushing $2k of compliance costs per year and I just didn't see that penciling out anytime real soon given my limited shop time so I decided to hold a hard "no sales" line and keep it strictly a hobby. I also know a lot of folks fly a little under the radar on some of these issues and never have a problem, but it didn't seem worth the risk to me.

I also have a rather strict "no outside work" clause as part of my day job employment contract, I'm pretty sure I could have gotten an exception for this as its very clearly not a competing business but it wasn't worth spending several hours of my life talking to the company lawyers about it given the above (and again flying "under the radar" could mean immediate termination which also didn't seem worth it).

So when folks ask "why don't you sell this" I ask them "how much time you got for the explanation" sigh...


On the IRS side the base rule is that a legitimate business has "a profit in 3 out of 5 years". You can obviously go outside of that, but your risk of audit goes up substantially and you risk getting reclassified as a hobby (back taxes, possibly significant penalties, etc..). In those cases your best defense is really good records and careful categorization of expenses and time. If you can show an expectation of future profit that is also a helpful factor. There was recently an interesting tax court ruling on this in favor of someone who never had a profit - the list of tests applied there is useful:
http://www.nolo.com/legal-encyclopedia/when-artists-work-business-versus-hobby-irs-analysis.html

The most relevant section of the tax code for the test for disallowed hobby/craft income:
https://www.law.cornell.edu/cfr/text/26/1.183-2

You might also find the IRS audit guidelines on this area useful (if you're into reading long boring documents.. and you made it this far so I guess likely? :rofl:):
https://www.irs.gov/pub/irs-utl/irc183activitiesnotengagedinforprofit.pdf
 
they have pretty much answered your question, get a real cpa to talk to for the latest and great explanations. in my case they take care of everything.. i just answer there questions.
 
Unless you are making a lot of money the "tax write offs" are a dream. The tax write off are only on the percentage of the profits from sales anyway.

If you are making $100 here and there or selling an item for 30 bucks or so, well, I didn't tell you but just put it in yer pocket and forget about the rest of it. Forget about tax write off too.

If you really want to be honest and give some of it to uncle sam - your 1040 on your income tax filing handles it without complication. It's just a line item called other income.

Sure, sell something.

If you are selling thousands of dollars per year, you can still handle it on your 1040 same way. Heck even 10-20 thousand dollars per year on the 1040 and you can still file business expenses.

It certainly dosen't hurt to get advice from a CPA, but the tax filing isn't really all that complex.

I use turbo Tax premium and that handles all of this stuff for I think I pay $49.00 plus tax.

When I had a full blown business with employees and I was incorporated, I needed a CPA.
 
You know, there are times i have to wonder how you all got so risk averse.
Most of you come from multi generational American families.
You live in the most entrepreneurial country in the world. 99% of the planet wishes they could live in the USA and have access to all you take for granted.
Where has the courage, spirit of adventure, entrepreneurship gone.
There are approx 330 million people in the USA in a single economic market with a common currency and incredible logistics companies providing dtd shipping services overnight across the continent.
The population is Internet savvy, tech savvy, heck created the very online shopping scene, you have Etsy, Ebay, Craigslist et al Facebook and You tube to reach the market at least cost.

Step back ask yourself , what did those pioneers of the country have???

All you really need to succeed is drive....and the willingness to break down the barriers. An entrepreneur does not let the IRA or insurance company or town or anything get in the way.
There are bigger obstacles to overcome....convincing your fellow citizens to part with their hard earned coin and take a risk on buying your wares.

The question should be how entrepreneurial are you.

If you need validation, ideas , encouragement from others , need to research to death the very idea of creating a business, hobby or not, then step back and ask yourself is this for me. Am i not too risk averse.

Where would we be if Thomas Edison, Henry Ford, Neil Armstrong, oh my list of heros goes on and on....worried about all i have read in these posts.
Yes its 2017 but did that stop the guy that just IPO ed Snapchat for billions.
You think you cannot make a few thousand????

But be sensible, you cannot expect your fellow citizen to pay more for your widget that he/she/it can buy it at the store or flea market.
You cannot produce at a snails pace and expect to get paid Auto worker Union wages for your output by your fellow citizens, they not mad, its a free market, if you can and are willing to compete have a good idea willing to do the work of marketing and selling it, get in the game. Be prepared and plan for failure, its a reality, if you dont have the appetite for failure cannot tolerate it economically DONT start a business.
Certainly dont go mortgage the family farm without having tested your market.
Recognize the market does not owe you anythjng, the market does not care how many hours you spent sanding or finishing your item. They dont care if you paid 1$ or $50 per board foot for your lumber.

If you cannot deal with these truths dont start any kind of business.

As to tax, one of the biggest causes of failure in business is lack of capital. Yet repeatedly small business owners spend valuable capital on items to try avoid tax.

Lets say tax rate is 50% then spending $1000 on a machine or tool to save $500 leaves your business $1000 short of capital whereas paying the tax would have left you with $500 cash in bank.
With $500 (add as many zeros to these numbers its the principle i am trying to point out) you can buy raw material make more widgets and generate income. With zero you go into debt to do the same.
With $500 you can advertise the items you have in stock with zero you cannot.

Believe me after working with small business for over 12 years now, this problem is an epidemic. And btw it gets worse when more zeros are added. I have a client right now that 3 years ago did something similar and spent 2.2 million to save 300k in tax and now are stuck with an asset that requires 1.5 million to fix to be able to use it.
They now need to loan the 1.5million, while their main business is growing and needs the 2.2 million of capital they had.

Sorry i did not sugar coat my reply but it takes a certain hunger to succeed as an entrepreneur and any business hobby or otherwise requires these intangibles. Its not for the risk averse.

My suggestion, if you have the desire DO A BASIC BUSINESS PLAN.
Thats how you mitigate risk . There are templates online that xan guide you as to what you need to cover and think about.
Do do the plan FOR YOURSELF, NOT FOR THE BANK which is what many do it for. The plan needs to encompass all facets of the business. This will have you discover aspects of a business you know little about yet need to. If you deal with those issues you will mitigate the risk of failure.

I say, fail to plan then plan on failure.
 
I hope I wasn't preaching risk aversion, Rob. I was trying to make several dynamics apparent. There is no free lunch. You're in the game or stay home. One does not go into business to avoid paying something as minor as sales tax on supplies. Risk aversion is handled by insurance and good record keeping - and paying the taxes owed. Don't do those things and the risks become untenable. I think it was Ryan who brought up the insurance issue. When a claim is made to an insurance company their first move is to find a reason to not pay the claim. I know a local guy whose house burned down. Didn't matter how the fire started, the insurance company could show the homeowner was operating a hobby business without the business insurance rider. They declined to pay. He went to court - and lost. A lesson learned. You gonna play the game, you have to play by the rules. Or pay the price later. And you thought the IRS was the problem!
 
Its not the risk of starting a business and failing that is the problem. For me, the biggest deterrent to starting a small hobby woodworking business is the insurance issue. I once considered selling a few bowls to offset tool/material costs but decided against it because of the inability to find reasonable insurance coverage. The example Carol cited is the exact reason for not selling anything shop/attached garage made. I called my homeowners insurance provider to ask about coverage and was told they would not cover even a small home hobby woodworking business. They referred me to a commercial associate who said they only covered businesses making more than 20K profit per year and the insurance costs were prohibitive (more than I anticipated in profit). I gave up after that. Maybe if I had a small detached shop it would be easier to insure or make it worth the risk of losing shop and tools to some disaster.
 
Exactly Ted.

Previously I had a stand alone building I was willing to risk. That left me with product liability insurance which ran about $100 per month. This time I will stay in a rented space and not use my personal shop. My lab space is costing me $70 per month - a steal no matter how you measure it. Total separation of shops and with more attention to legal separation as well.
 
Yup, I'll second what Carol and Ted said. Basically its a question of ROI and you need to figure the costs for your specific situation and area and see how it pencils out. I believe that Carol,Ted, and I live in some of the less friendly areas of the US towards this sort of thing so our experiences are perhaps overly negative in comparison to many others experiences. In my case the fixed costs were close to/possibly over the expected income given the time I can allocate to it, so it didn't work out. Other folks with more time or in areas/situations with lower overhead will end up with a different calculation.

To the "things to check" list I would also add on that in _some_areas_ you are also required to pay a use tax or "personal property tax" on equipment used in a business. The rates for this vary widely from state-state and in some cases county-county or city-city depending on how the tax is levied, and usually (pretty much everywhere now I believe..) there is some baseline under which you are exempt from paying (but you generally still have to file the forms).

Around here it's often be cheaper to rent a commercial space than to try and do a small business out of your house because of the regulatory and insurance overhead. I recently read a book by one of the more successful bakers in Portland OR ("Flour Water Salt Yeast" https://www.amazon.com/Flour-Water-Salt-Yeast-Fundamentals/dp/160774273X). The owner originally bought a small acreage in the Eugene OR area and was going to do a backyard brick oven bakery (I mean hey people can do this easily enough in regulation heavy California... should be a cakewalk here right? wrong!) well six months later with a stack of forms and filings and cross filings tall enough you could barely see across them, the conditional use permit was denied, primarily because some of the neighbors "didn't want to smell bread cooking all day" :huh: :rolleyes:. He ended up selling that property and moving to Portland and renting some commercial space (which, having different zoning didn't have to deal with the same issues) and (with the usual struggles and long hours of someone opening a cutting edge business) eventually became one of the top bakeries in the region (certainly quality wise if not size). So in the end he succeeded but the dream of an outdoor brick oven bakery died along the way even though it would have been a perfectly viable (and much less expensive to start) business model in most of the rest of the country. There's another bakery trying to open up in town here that was just pushed back another 3-6 months on final inspection because the last inspector decided they needed another $15k worth of time consuming facilities modifications (even though they had fully consulted and gotten pre-approval for everything up front). I'm hoping they make it through that but its not going to be easy. I'm maybe picking on bakeries but a lot of similar problems arise for any small business locally and I know of several small local cabinet/woodworking shops who have plenty of space in a shop at their property but moved the business elsewhere for regulatory and insurance reasons (these aren't storefront shops either).

Other parts of the country and/or physical layouts (detached shop. etc..) and/or insurance companies change the numbers a lot and you do see more home businesses in those areas where you don't here (Oregon might not be the worst place to start a home business but they're certainly working at it).
 
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Another story that will curl your hair. Not business related but could be. A friend had a Cessna airplane to fly as a hobby. Turns out there was a use tax on said airplane that the owner had no knowledge of. Am employee of the IRS overhead his enthusiastic stories of flying. One day the IRS guy got in trouble at work so in an ttempt to redeem himself and having discovered the use tax, reported the airplane owner. Cost a bundle. And even others int eh flying community were surprised that such a tax could be levied.

How can it apply here? If you are selling your widget way under market and appearing to be doing well, a disgruntled business owner may have an acquaintance who works for said scary government agency. Not only are super computers tracking every transaction, if some one with the 'right' connections wants to cause mayhem, it is ridiculously easy to do so. Not easy going into business. Its often worth it, Ryan's baker, as an example, but you do need to go into it with your eyes wide open.

In short, your motivation has to be much more than saving a few sales tax dollars or making back some materials money. And that's what Rob was also getting to.
 
around here in minnesota, the use tax is a one time thing. if joe x were to buy a drill press from a company in another state, not paying any sales tax in that state, minnesota requires him to file the use tax for what he would be charged for sales tax, when the drill press crosses the state line. i'm still trying to figure that one out, how one state can charge a form of sales tax, on a purchase that occurs in another state.
 
I think most state use tax applies to just about anything bought out of state, including internet purchases. So anything you haven't paid sales tax on, your state wants you to pay that use tax on, it's their way of leveling the playing field for local businesses being undersold by internet sales.
 
There is certainly sales tax recovery, but many states also have a yearly assessment on all property used as part of a revenue generating business. This is an ongoing tax you have to file and pay yearly or quarterly.

For example here is Oregon's system:
https://www.oregon.gov/DOR/programs/property/Pages/personal-property.aspx

Usually the taxes are fairly small, somewhere between a fraction of a percent and a couple precent of the assessed value (the method of assessment varies).

There are a few States left that also assess this tax on personal personal (not just business personal) property. Most commonly the tax lands on luxury items or other higher value items (which can have special extra taxes levied) which is where I would bet Carol's friend with the plane got caught up.
 
Risk - Opportunity - Small Business - Hobby Business - making a few bucks on the side?

What the heck are we talking about here?

What I hear the OP asking is - Is it worth it to make a few bucks on the side, but the OP is confusing "tax breaks" into the question.

I don't see the need for a business plan to make a few bucks on the side out of a small home some in garage or basement.
Heck, for anything under $5000 annually I don't see the need for a business plan, insurance, incorporation or anything like that.

NOW - IF - the work being performed was being done in someone else's house - THAT - is a different story.
Then Liability Insurance becomes an issue, but not much more than that.

BUT - if one was to make a widget in one's home work shop and sell it - that is too simple for all of the above.

I know electricians at work that help some of the coworkers on weekends to replace a light switch or a receptical or a light fixture in the house. They make a few bucks on the side. Some pay the federal and state income tax on the form 1040, some do not. Technically - they are in business, and do not have a business plan.

Just do it ---
It's not at all complicated and it is very legal. All the gov wants is the income tax money.
The 1040 allows the reduction of materials on the object sold and you pay tax on only the profit.
The income tax is filed on the social security number - don't even need any tax ID number.

Make a widget - $10 in materials, $20 sell price = $10 profit.
The gov wants a small piece of the $10 profit - not all of it.
In all honesty that is all there is to it. Very Simple.



Getting a State sales tax form is pretty easy, at least in Mass.
If that is not none with small sales - like I said under $5000 or so, it is not really noticed, but I didn't tell you that.
Lots of craft shows require a State sales tax ID number for the vendors.
I think though - the original OP question is even smaller than that.


********
ON THE OTHER hand - if the OP is asking about developing a small woodworking business as a source of income to feed the family - THAT - is an entirely different question with entirely different circumstances.
 
My "expertise" is a wife who is a CPA specializing in small and start-up businesses.

If your workshop is a hobby, then the tax deductions are very limited. If it is a business, then your expenses can offset your income from that business, but the use of your shop for personal (hobby) is quite restricted. Most of the few things I make for us are done as training or practice or prototypes, so are considered business activities. The general rule is that you must make a profit (any profit) at least one year out of seven; if you have more than 7 consecutive years with loss you may have to prove that you were trying to make a profit.

As a business you will often be asked to donate something to a charity for the tax advantage or advertising. Beware, all you can deduct is the cost of the materials, not your time or machinery, and certainly not the commercial value of your donation. When I get a request from our church, I quote a price and refuse to give them receipts as hobby people would. My price is very attractive (amazing how bad my estimating can be at times), but the entire process is a business transaction, not a hobby activity, so is not considered personal use of my shop.

You do not need to form a separate entity for your business - in fact, it is often preferable not to do so. My woodworking business is "Charles Plesums" (not Charlie) so I am not doing business under an assumed name. My taxes are filed as Schedule C on my 1040 (if you use Quicken, the Deluxe version is ample, you do not need the expensive business version). You do not need a separate bank account as long as you are scrupulous about how you keep your records. (My wife usually recommends a separate bank account, since most of her clients are not good at record keeping).

You can choose Cash basis accounting. When you do so, all expenses are considered to occur when the bill is paid, all income happens when payment is received, and there is no such thing as inventory or accounts receivable. If you buy wood in December and sell the product in January, you may have a loss one year and an overly large profit the next year, but that is legally okay - you can carry the loss forward to offset the profit the next year. Any leftover wood is legally scrap, with a legal value of zero, since there is no such thing as inventory.

From an insurance perspective, the biggest issue from my insurance company is that customers do not come to my home.

I have a friend who is a full time furniture maker from his home (he supports his family woodworking). When his neighbors complained to the city, they came out to investigate. They admitted that if he kept doors and windows closed, the activity was entirely in his home, and that was nobody's business. The noise was no worse than loud music or fighting couples elsewhere in the community. My building furniture is legally no different than an artist painting a picture, an author writing a book, or the salesman next door having conference calls hours per day.

I have tried to put these points, and others, together on the Solowoodworker web site.

I should add that in the 12+ years since I "retired" from a "real" job, I have made a profit (sometimes small) every single year, and have paid for all my equipment in the year it was purchased.
 
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About 15-16 years ago, I was starting to do 'serious' woodworking, meaning something other than hammer a piece of junk together. When I found I could be pretty good at it, I gained the confidence to move to more involved projects using 'real' wood; i.e., cherry, etc., rather than pine. Of course, when people saw what I was doing, many wanted to know if I could build X, Y or Z for them. I took the stand that I might be willing to go that route, but not for free. I would quote a fair price for a customized piece and would never hear about the project again.

I did a couple of commissioned pieces for people who recognized the value of such. In doing so, I found I didn't really want to get heavily involved in items for other people. I wanted to build more furniture for our home and some for family and friends. In other words, it became more important for me to retain the 'hobby' aspect and do what I want when I want to do it.

When asked along the way about how much I have invested in my shop, some people have told me what a great boat I could have for that amount. I don't want a boat. Others have asked when I get an opportunity to play a round of golf. I explain that I played on-and-off for a number of years but lost interest. Woodworking became a source of enjoyment for me.

Having said all this might not answer your question, but I hope it gives food for thought. Some of my thought was based on people asking how much a particular keepsake box I made would cost, if they wanted one. When I said it would be $115, their comment was something like, "I can get the same thing at Walmart for $19." I told them to go for it. Most people have no concept of the difference in value between an item built with quality woods and one built of cardboard.

'Nuff sed.....
 
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