As a hobby, Jane creates and sells oil paintings. During the current year, her sales total $8,000. How is the tax treatment of her hobby different from the treatment of a trade or business, if
- Her business expenses total $5,600?
- Her business expenses total $10,000?
- Assume that Jane itemizes her deductions and that she has an adjusted gross income of $42,000 before considering the effect of the hobby. Discuss the actual amount of the deduction Jane would receive in parts a and b.
- Her business expenses total $5,600?
Because Jane’s activity is a hobby, her sales must be reported as gross income and her expenses are allowed as a miscellaneous itemized deduction. Her deductions will be subject to the general limitation (2% of adjusted gross income) on miscellaneous itemized deductions. Jane should report:
Gross Income $ 8,000
Miscellaneous Itemized Deductions $ 5,600
Instructor’s Note: The solution in part a, b and c assumes that the expenses related to Jane’s hobby are not for interest and taxes that could otherwise be deducted as itemized deductions.
- Her business expenses total $10,000?
Because Jane’s expenses exceed her gross income, her hobby expenses are limited to the $8,000 of income from the hobby. She should report:
Gross Income $ 8,000
Miscellaneous Itemized Deductions $ 8,000
Nondeductible Personal Expense $ 2,000
- Assume that Jane itemizes her deductions and that she has an adjusted gross income of $42,000 before considering the effect of the hobby. Discuss the actual amount of the deduction Jane would receive in parts a and b.
Hobby expenses are deductible as miscellaneous itemized deductions, which are subject to a 2% of adjusted gross income limitation. The $8,000 of hobby income will increase her adjusted gross income to $50,000. Assuming that Jane has no other miscellaneous itemized deductions, the allowable hobby deductions must be reduced by $1,000 ($50,000 x 2%). This will leave her with an actual deduction of $4,600 ($5,600 – $1,000) in part a and $7,000 ($8,000 – $1,000) in part b.
Part a Part b
Gross Income $ 8,000 $ 8,000
Hobby expenses $ 5,600 $ 8,000
Less: 2% of AGI ($50,000 x .02) (1,000) (4,600) (1,000) (7,000)
Net income effect $ 3,400 $ 1,000
