Is your Blog or Website a Business or a Hobby?

Many of you have taken time to read my post about Google ad revenue being considered self-employment income and the need to report that income on your personal income tax return on Schedule C (IRS tax form) for income from a trade or business.   On Schedule C, you may claim expenses related to this income  to reduce both the income tax and self-employment tax.

While your expenses may be claimed to offset your blogging or website revenue to zero, you may experience a situation where your expenses exceed your revenue, resulting in a business loss.  Ordinarily, business losses may be claimed as an offset to other income on your personal income tax return, such as wages, interest and dividends, or retirement income. However, if a loss is attributable to an activity not engaged in for profit, the loss is not allowed as a deduction against other income.  The IRS and tax practitioners refer to this limitation as the "hobby loss" rule.

There is a presumption in the US tax law that an activity is presumed to be engaged in for profit if gross income is greater than expenses for 3 out of 5 consecutive tax years. Just because you meet the presumption, you are not necessarily free from challenge by the IRS if you have small profits in the 3 out of 5 years compared to large losses in the other 2 years.

You are not necessarily dead in the water if you can't meet the 3 out of 5 year test.  If you claim business losses on your tax return in more than 2 out of 5 years, you don't submit any extra paperwork with the return you file your tax return, but if you get audited by IRS, you will need to be able to prove by facts and circumstances that your blog or website is a business activity that is engaged in for profit.

Some of the factors that get considered in determining whether you have a business or a hobby are:

1. Whether the activity is conducted by the taxpayer in a business-like manner.
2. Whether the taxpayer has the appropriate expertise to conduct the activity.
3. The amount of time and effort spent by the taxpayer in carrying out the activity.
4. Whether assets used in the activity are expected to appreciate in value.
5. The taxpayer's success in other activities.
6. The taxpayer's history of income and loss from the activity.
7. The amount of any occasional profits from the activity.
8. The financial status of the taxpayer.
9. Elements of a personal pleasure or recreation in the activity.

Referring to your activity as a "labor of love" or a "hobby" is probably not a good fact. 

Hobby losses aren't the only hurdle you'll have to jump through to claim business losses against other income.  There are also at-risk rules and passive activity rules to consider.  

My original post was concerning your ability to offset your blog and website income with deductions.  You are able to do that even if your business is considered to be a "hobby" for tax purposes.  But, you won't necessarily be able to offset other income you may have earned with the extra expenses from this activity.

Complicated? Yes.  Consult your tax advisor for a more detailed analysis of your situation.  This article is general in nature and may not take into account all aspects of your tax situation.  You can't rely on this article to avoid penalties with the IRS or your state government.  Plus, if you are reading this in another country besides the United States, your laws may be different. 

Cancel Christmas? Dissecting a Tax Drama?

*** UPDATED ***

Mike Cane pointed me to this unhappy tale about the IRS sending an unexpected tax bill to the creator of the Online Etymology Dictionary related to their Google Ad revenues:

First the warning: If you have a Web site, and you ever put Google ads on it, and you ever made a penny off those ads, congratulations! The Internal Revenue Service owns you. 

According to the IRS you are a private contractor employed by Google; you are a business; and you will have to pay business taxes and the rates that go along with them. Doesn't matter how big you are, how long ago you put those ads there, or whether you made $20 or $20,000 off them. 

Did you know that? I didn't. I had to start putting Google ads on etymonline in 2005, because people kept ripping the entire content at one gulp and it was crashing the servers. Some of you regulars might even remember that time. The only solution was to rent more expensive servers, and the only way I could afford that was to minimally monetize the site with the smallest possible ads.

I had been declaring that ad revenue as "extra income" and dutifully paying my taxes on it. Suddenly last year the IRS informed me I owed them scads of money that I didn't have. Link to "Cancel Christmas"

What I gleaned from the story (and subsequently confirmed with the author) is that the web site creator reported the Google Ad payments as income but did not treat them as self-employment income.  If you are an independent contractor or operate a business as a sole proprietor, you are not only subject to income tax but also to self-employment tax.  Self Employment tax is the equivalent of the FICA and Medicare taxes that are withheld from wages. When you are an employee, your employer pays half of the tax, but when you are self-employed, you must pay both halves.  The tax rate is 15.3% on the first $106,800 and 2.9% of anything over that amount.

Self-employment tax is imposed on your  net business income, not gross.  What may have happened in this case is that the author reported the Google Ad payments as "other income" on page one of Form 1040 and did not file Schedule C, which is where you report net income from a business.  Had the author reported the Google Ad revenue on Schedule C, he would have been entitled to reduce the amount subject to both income tax and self-employment tax by allowable deductions, such as the payments to the web host, which is supposedly what the Google Ad money went to pay for.

It may be that the web site creator can still file amended returns for 2007 through 2009 and reduce the assessed amount.  Generally, the statute of limitation runs three years from the date you file your tax return.  The taxpayer does not have to merely accept the tax assessment in a situation like this.  In my opinion, the next step would be to submit amended returns to the IRS moving the income to Schedule C and reporting the business expenses that offset the revenue.  It may be that by doing so, the assessment can be reduced to zero.  The IRS will take into account additional facts or a change in the way that items are reported, but they need you to provide them with the additional information in a format that they can accept.  That is where your CPA, tax attorney or enrolled agent can provide valuable assistance.

Mike Cane writes on his blog:

The decree would be: IRS calculates the monetary value of using a free site and taxes us based on that use. There are “in-kind” taxes that could easily be contorted to make this happen. The IRS could rule we’re obtaining taxable value in a way that makes us allwind up owing them something. 

Or: They could decree that since WordPress is deriving monetary value from the ads on this site, I am therefore a WordPress contractor somehow liable for the value I’m adding to their system. Link to Mikecanex.wordpress.com

IRS can tax you on value that you derive but not on value that you create for others.  Bloggers should be cautious about bartering to avoid recognizing taxable income, but IRS will tax Wordpress on value they received, not Mike Cane.

Bottom line: If you are a blogger or web site creator and receive Google Ad revenue, whether $20 or $20,000, you should report that as income on Schedule C. You should also report all the deductions that you incurred in earning that income, such as your web site hosting, monthly ISP bills, and maybe even depreciation on your computer.  The net income is subject to both income tax and self-employment tax. Whether you consider your blog or website to be a business or a labor of love, if you receive money from advertisers, from a paypal link on your page, or by any other means, your web site is a business. I join the creator of the Online Etymology Dictionary in hoping that his unhappy surprise helps others avoid a similar fate.

Twitter Peeps are Real People!

I use Twitter all the time and I enjoy social networking on a variety of topics - computers, gadgets, music, politics, e-books. But, my first love is taxes. Yes, that's right, taxes. They don't call me "tax man" for nothing. When I first started using Twitter, the people I followed were mostly tech industry early adopters. While I enjoyed reading what these people had to say, I knew so little about their business that it was difficult for me to make any meaningful contribution in reply to their pithy tweets.

Where Twitter value became apparent is when I began to discover people on Twitter who share my passions. Every twitter friend doesn't share all my passions, but I have assembled an eclectic mix of accountants, political commentators, musicians, worship leaders, and gadget lusting technology geeks. These are folks that wouldn't exactly put themselves together in one room or talk to each other if they did, but on Twitter it's one big gathering.

There are still those luminaries that I follow but don't really converse with. I do that mainly to catch what they have to say without having to remember to visit a bunch of different blogs every day. When they post something on their blog, they usually post a link on Twitter, so it's click bam boom and I'm there.

I am pleased to see a growing number of tax and accounting related Twitter friends too. My industry isn't known for social networking of any sort. An outgoing accountant, the joke goes, looks at your shoes instead of just looking down at his own. Yet, here we are!

I am pausing to write this reflection after getting off the phone with @alillyjohnson. She's with the Ohio Society of CPA's. One of my clients in Texas does business in Ohio and I need some help. I made a post on Twitter and Amy promptly answered the call. Wow! I suddenly am connected with professionals in Ohio! My little 5-person CPA firm has national and even international reach thanks to tools like Twitter!

Sure, I may post about what I'm having for lunch. But I consider that like the test of the emergency broadcast system that used to beep at us from our TV sets during the cold war. The little posts of interesting or not-so-interesting tidbits keeps the network alive so that in the case of an actual emergency you know who to call.

Apple Tax Advice: $1000 deduction?

This Apple ad has been bugging me all day. What $1000 tax deduction are they talking about? Why $1000?  Section 179 of the Internal Revenue Code allows taxpayers to expense 100% of the cost of new assets purchased for use in the taxpayer's business?  There's no $1000 limit to this deduction.  However, there are other limitations. For example, the Section 179 deduction can't create a tax loss.  Plus, the IRS classifies computers as listed property, so tax deductions are limited to the percentage of business use.  If you use your computer partly for business and partly for personal use, only the business percentage may be claimed as a tax deduction.  I wish I could figure out exactly what Apple was talking about in this ad.  Any ideas?

Hurricane Ike: Extended Due Date is 1/5/2009

Residents of Texas counties impacted by Hurricane Ike have until January 5, 2009 to file most tax returns and tax payments. Check IR-2008-107 for all the details.

Another Tax Deadline is "in the can"

October 15 is the last day to file a personal income tax return in the US for people who requested an extension of time to file back in April.  This is also the deadline for many of the state tax returns filed by corporations.  

As I get going on October 16, in the after-math of the October 15 deadline, I am relieved to put this madness behind me for another year.  People who ask for extensions fall into two categories:  (1) procrastinators and (2) otherwise organized people who are waiting on partnership K-1's generated by people in the other category.  Either way, it's always a last-minute process to get those tax returns out the door.  Thankfully, all that is behind me for another year.  

Now, I can enjoy the fall.  I hope that you do the same.