Tax Tips Blog

Kurt writes:

I sponsor my son who races dirt bikes in semi-professional events. My previous accountant deducted this as advertising, but my current accountant says it’s not deductible.

I think about Nascar and how the companies who support the drivers must get that as a tax deduction. If they can do it, why can’t I? I attempted searching the IRS website, but couldn’t find anything this specific.

I assume that for it to qualify as advertising, there should be stickers of some sort on the bike in the business name, or something of this nature.

In 2007 I purchased a new bike for my son’s races. It cost around $7K and my prior accountant called it all advertising. Should I just tell my current accountant it was classified wrong and it should have been depreciated instead of put into advertising and that would solve this problem?

So, basically my question is if you have any info on sponsorships and how they are to be deducted. I appreciate any help!

My reply:

Hello Kurt, thanks for writing.

If you gave money to your son for advertising, then your son must be in the business of racing dirt bikes and then he’d report the sponsorship income he received.

If you gave the money to the event your son was in, then the event would acknowledge the receipt of the money and state whether or not anything was provided in return for the payment and if so, the FMV of whatever provided was not deductible, but any additional monies may be. You’d have to read the letter to determine if any additional monies should be classified as “advertising” (if they advertised for your business in some way), a “contribution” (and if so whether or not it’s deductible and to what extent) or a combination of the two.

If you’re giving the “advertising/sponsorship” money to a non-profit, this is a good place to start your research: http://www.irs.gov/pub/irs-tege/eotopico94.pdf.

As for the bike that was purchased in 2007, who owns the bike now? You can’t depreciate a bike you don’t own. If your business gave the bike to your son, the business no longer owns the bike. The bike was either a donation, advertising, a gift or a non-deductible expense to a family member. Again, it really comes down to whether or not your son reported it as income.

Best wishes,
Gina

I rarely continue conversations, past the first question, but I received this response and it was obvious that I wasn’t clear in my initial reply so I had to respond. The point I want to emphasize is that this is why no one should take advice that they read from anywhere on the Internet without first discussing it with their own tax professional. You may think you understand the reply or that your situation is exactly the same as the poster, but it may not be.

Kurt writes back:

Thank you for your answers…it makes a lot of sense when spelled out like that. If you don’t mind, I want to be a little more specific and see if you agree with my conclusion…

The money I expended for “advertising” is payments to vendors for bike supplies, such as tires, oil, etc. So, in essence, I am not directly giving money to my son, but I’m actually paying vendors, who are reporting it as income. So, with this thought, it would make sense that I could deduct it because the other end of the transaction IS being reported as income on the vendors return. Maybe it is just being classified incorrectly. Also, in regards to the bike, I do own it, so it seems as though this could be deductible too, since the vendor will pick it up as income. Just thru depreciation.

Please, let me know your opinion on my conclusion.

My reply:

Your business is only allowed to deduct expenses that are both “ordinary” and “necessary” for your type of business. You never told me what type of business you are in so I do not know if it is both “ordinary” and “necessary” that you purchase, bikes and bike supplies for your business.

If it is not “ordinary” and “necessary” that your business purchase “bike supplies, such as tires, oil, etc.” then it’s not a legitimate business deduction. Thus you wouldn’t be able to deduct anything, certainly not advertising. These vendors (the people you are paying) are not providing you any advertising are they? And if they are, then are you “overpaying” for the bike and bike supplies? If so, then the “overpayment” may be considered advertising, but not the actual merchandise that you receive.

In addition if you give your son ANYTHING from your business, whether it be money or property, then your business would have to report whatever it gave your son and he would have to include it in his income, or it’s not deductible for your business.

If purchasing “bike supplies, such as tires, oil, etc.” is considered “ordinary” and “necessary” in the business that you are in, then yes you could capitalize the bike and depreciate it, but if this were the case you’d probably already have other bikes on your balance sheet that you’re depreciating so you wouldn’t be asking this question.

There are actually ways you may be able to arrange your affairs such that it becomes legal to deduct expenses such as these. The easiest would be if your son were in the business of professional biking. If you were my client I’d start by asking you these questions:

• How old is the child?
• How long has he been in biking competitions (for money and not for money)?
• How often does the child win?
• What is the probability or potential of your child earning more money than he spends being a professional biker?
• Do you know of anyone who has a child who is a earning more money than he spends being a professional biker who would be willing to mentor you and your son?

If you can answer the above questions in such a way that it seems reasonable that your son could have a profitable company, then I’d discuss the positives and negatives of it. Once your son has a company then instead of purchasing him “bike supplies, etc.”, your business could write his business a check for your son putting your business’s name & logo on his bike, helmet, T-Shirt, etc. and it would become advertising for your business and sponsorship income for your son’s business. If your son doesn’t race then there was no advertising, so timing is essential. If your son never wins then there’s two problems, the first and the one I’d be most concerned about is that the IRS would view the son’s biking as a hobby and not a business. In addition, the advertising would have to be really cheap, practically free for a losing biker.

Best wishes,

Gina

Denise asks: My daughter in law has her teaching degree but she is staying at home and home schooling their 2 sons. Can they claim any of their expenses or is their a credit for home schooling? I have looked and can’t find anything I really understand re this issue.

My response: Hello Denise! The short answer is no.

The educator deduction was extended at the last minute, but it is only available for teachers who taught at a public or private school, so it would not apply to your daughter-in-law.

Since your daughter-in-law does not charge her children for their education then her intent is not to make a profit and only benefits her own children; therefore, this is not a business nor a hobby.

All of her expenses relating to homeschooling her children are considered nondeductible personal, living and/or family expenses. If your daughter-in-law were to speak to a qualified tax professional they would certainly discuss alternatives for future years, such as setting up a tutoring business, establishing a Coverdell Education Savings Account , etc.

Best wishes, Gina

Karen from Michigan asks: I just read your post about hobby income. The rules seem somewhat bizarre, in that it seems as if someone who is deliberately trying *not* to make a profit — merely asking to be reimbursed for the cost of raw materials for something she makes to give to another person — would end up paying income tax on what is essentially a reimbursement. I desktop-publish fanzines — amateur collections of stories and art. The standard price in the fanzine community is calculated at 10 cents per black and white page plus one dollar for every full-color page: in other words, people are charged just the cost of running one off at Kinko’s (not counting the binding). No one is supposed to make a profit off of the community. I didn’t mind putting in hundreds of hours on a labor of love — even though I definitely spent more on ink and toner and paper than I took in –, but it’s disconcerting to find that because I’m the one who did the copying work, the payments I got — essentially reimbursements — are “income.” The next time someone asks me to run off a copy of one of the zines I publish, I may have to decline — I can’t afford to pay the government $3 for each zine. Yet I can’t declare that it’s a business, because on the first page of each zine, it clearly states that there’s no intention to make a profit. Is this really the way it is? If a jewelry maker makes a necklace for a friend and asks the friend to just pay her back for the raw materials, is the jewelry maker stuck with having to pay taxes on that “income”? If an amateur photographer photographs a friend’s wedding for free, but the friend pays him back for the film, the photographer has to pay taxes on it? Something about this doesn’t seem right.

My reply:Hello Karen! Thanks for writing.

I agree that I don’t think the rules for reporting hobby income and expenses are fair. Your income would be reported as “Miscellaneous Income” and you expenses would be reported as “Miscellaneous Itemized Deduction”, which has various limits and most do not receive a benefit from it. This usually results in exactly what you stated, you’re reporting the income (the reimbursements) and no expenses. This is just one of the reasons why, in my opinion, a good tax consultant is worth their fees.

They will tell you how to make the most of situation such as this. The advice I provide my clients who are in a situation such as yours is to convert your hobby into a legitimate business, because that is the best way to get around these rules (in my opinion and yes there is another way). I realize you said that this publication is not for profit and that is not their intent, but YOUR intent can be to make a profit. Once your intent is to make a profit from doing the same thing, in your case, desktop publishing, then you can report your income and expenses on Schedule C, showing a loss and taking a loss until you do finally make a profit. I consider it my job to help my clients find ways to try and make a profit (or increase their profit) in the future and make sure they document their efforts trying to make a profit.

For your situation, these things would include (the rest of which you read in my other article): 1. Finding someone who has made a profit from desktop publishing and asking them to be your mentor. 2. Make yourself some business cards and disperse them, documenting as best as possible where they have been dispersed. 3. Advertise your business and skills seeking additional work. Obviously more than the 3 things above would need to be done, but that is an excellent start.

Best wishes, Gina

Eva from California wrote:Dear Gina, I found your blog by accident and boy am I glad! Big question…early this year I tried to start a small business. Within 3 months I figured out I wasn’t going to make any money so I quit. Am I still entitled to the deductions? I was also thinking of starting this other business. It’s a no brainer but if the same thing happens should I deduct the expenses? How many times does the IRS let you do this? Thanks! Eva

My reply:Eva, I’m glad you found my blog.I’m sorry I didn’t respond sooner, but as you probably noticed from my last blog entry I was pretty busy last week.

The sad truth is that most businesses fail to make money. This in and of itself, does not mean that you will not be able to deduct your business expenses.

The fact that you only spent 3 months trying to make it succeed may make the IRS believe it was only a hobby. The rules for determining whether or not an activity is a business or a hobby are quite complex and you should seek the advise of a qualified tax professional to see how your activities should be classified.

In general, the IRS uses the following 9-Point Test to determine if your activity is a business or a hobby:

1. The manner in which the activity is conducted

2. The expertise of the taxpayer

3. The time expended on the activity

4. The expectation of profit

5. The success in other similar or dissimilar activities

6. The history of income and losses

7. The amount of “occasional” profits

8. The financial status of the taxpayer

9. How personal pleasure or recreation contribute to the business.

If you intended to make a profit and a tax professional (and the IRS) concurs that your activity is a business, you can claim all your applicable business expenses. If your business expenses exceed your income for the tax year, you can claim a loss for the year, up to the amount of your taxable income from other activities. Any remaining losses may be carried over into other years.

If your tax professional (or the IRS at a later date) believes that your business never intended to make a profit your activity will be classified as a “hobby” and your losses will be limited to the amount of income generated by the activity. “Hobby Income” is reported as “other income” on your Form 1040, Individual Income Tax Return. “Hobby Expenses” are only deductible if you itemize deductions on your tax return. They are considered “miscellaneous itemized deductions” and you may only deduct the portion of them that, along with any other miscellaneous deductions, exceeds 2 percent of your adjusted gross income.

Depending on your particular tax circumstances this can result in all income form the hobby being taxable income with no offsetting deduction for hobby expenses. The IRS does not put a limit on the number of businesses a person can own or hobbies that a person wishes to engage in.

I am not familiar with any specific rules that California may have, please see a tax professional who is familiar with California taxation.

Best of luck with your next venture,

Gina