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BUSINESS Q & A BY ED “LOMAX” ESTRIN
As many of you know I am a California CPA and have served as State President of the Society of California Accountants, as well as filling each of the officer positions prior to that. I believe that I have helped WCA with our finances and our record keeping and I want to continue to help WCA move forward. I have brought a financial professional approach to the record keeping of WCA
Q. I am starting a new clown business and wonder what records and receipts I need to keep.
A. You need to keep records on all of your income and your expenses. And you need to keep records on the non cash items that will allow you to take tax deductions at the end of the year. I suggest you use a simple computer program such as Quicken to keep track of the income and expenses.
You also need to keep track of mileage because use of your auto will probably be a large expense. There are two ways to deduct use of your auto, standard mileage or actual expense. Either way requires you to know the miles you drove for business but the actual expense method requires you know the total miles you drove for the year and the total amounts you spend on the auto including gasoline, repairs, car washes, new tires, insurance etc. Then you total all of the allowable expenses and allocate the expenses based on the business use of the vehicle vs. non business use. Here, business use would be your clowning business and everything else would be non business.
Another issue for you to be aware of is hobby vs. business rules (more on this later). As long as you have a profit in your clown business at the end of the year this would not be an issue. If however, you do not make money when everything is added up then you have to look at the hobby rules. In that event, you can deduct your proper expenses up to the amount of income you are claiming but no more. You cannot create an income tax loss to offset other income, such as wages, from a hobby but you must report all income you are paid for services even if it is from a hobby.
In addition to the above tax records, I recommend that you keep records about the jobs you do and your experiences. What went well with the job and what did not go well. That way you can see where you had a problem and try to determine a better way to handle the problem in the future. An example might be… you were hired to do magic and balloons and you expected it to take 2 hours and so that is what your charge was based on. But when you got to the party there were 60 kids (you were expecting 25). Perhaps you need to create a questionnaire when you take jobs to include how many children will be at the party and what is the average age? It would also be good to know the expected age of the children.
You can see that starting a clown business is like any other business. Good records and forms to help you make it grow are always needed.
Q. I am confused about taxes and my clown business. Can you give me some information?
A. The rules for deducting your clown expenses depend on what you are doing with your clowning and if you are being paid for your gigs or just doing volunteer work. The tax code says to deduct “business” expenses you must have a “profit motive and operate in a business-like manner”. That means that you must be keeping good records, trying to get enough jobs to cover all or your expenses and working at it like a JOB. If you are doing this then you report your gross income (the money you are paid for the work you do as a clown) on schedule C of the tax return and then take your related business expenses on the same form. Besides your direct costs of balloons, face paints, and disposable props, you can also deduct your travel (auto) expenses. BUT you MUST keep good and current records. Your travel records need to record who, what, when, where, and why. You can deduct the cost of going to and coming home from the supply store to buy your supplies, going to and from your jobs, etc. We all hope that at the end of the year, the income exceeds the expenses. If it does, then there is no question you had a profit motive (you did make a profit) but what if you do not. If that happens for too many years in a row then the government might claim you are not in business but rather it is just a hobby. If the government determines (or you just decide you do not have a profit motive but just do it for fun and sometimes get paid) you have a hobby then you can deduct your expenses of clowning but only to the extent of your gross income. That is, if your expenses exceed your income, you cannot take a tax loss in the current year but rather the excess expenses are just not used.
Q. What is the best system for my record keeping for my clown business?
A. There is no best system. It depends on your computer skills, what information you want and reports you want and how much effort you are willing to put in. At the high end there are business software programs such as Quickbooks. They give you complete books and records based on your input and full financial reports. A lesser system would be check writing and tracking systems such as Quicken. They keep track of your checkbook and can be used to record your fees taken in and your expenses paid out. Finally, many people still just keep track of their “business” with a notebook noting “fees: received and “expenses” paid out. What is important is that you keep track during the year so that at the end of the year you have the information for your tax return. If you have a business it needs to be on Schedule “C” of the 1040. If you determine that you have just a hobby you still need to complete Schedule C but must limit your expenses.
Q. Based on your prior information I think I am just a hobby. I am a CARE clown and 100% of my performances are donated and done for non-profit organizations. Someone told me that I cannot deduct my clown business because it is a hobby and hobby losses are not deductible. What can I do?
A. Since you received no payments you should not show this on your tax return as a business. Rather, I believe you can deduct your cost of materials and mileage as contributions on schedule A of the tax return if you itemize. If you do not, then there is no deduction but of course, you get the benefit of the good work you are doing for people who, I am sure, enjoy your clowning.
They are exactly right, hobby losses are not deductible. But what are hobby losses? That’s a can of peanuts with the coiled snake inside. And can hobby losses ever by deductible?
Please forgive me if I start talking like a CPA but this is tax stuff and sometimes you have to be sure you cover it correctly or else .
The starting place for this question, from a tax point of view, is Publication 535, Business Expenses. This is where the government discusses “Not-for-Profit Activities. That is what they call a hobby, a not-for-profit activity. There are nine factors that must be considered and they say that no one is more important than any other but I do not agree and you will see why.
Here are the nine factors and my comments.
1. You carry on the activity in a businesslike manner. OK, you have to keep records and try to make money. That is important. You must “try” to make money. If you charge less then it cost you to do the job it will be a hobby and not deductible.
2. The time and effort you put into the activity indicates your intent to make it profitable. Do you work at being a clown? Do you advertise? Do you treat it as a business? Do you continue to learn and try to grow?
3. You depend on the income for your livelihood? This may not be relevant since I treat my clown business as a business but it is not my principle business and I do not depend on the income for my livelihood. However, for me it is not a hobby.
4. Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business). You’ve got to work at being profitable even if you lose money once in a while.
5. You change your methods of operations in an attempt to improve profitability. This is important! This is important! This is important! This is important! You get the idea. You must show a profit intent to have your clowning be a business even if it loses money! This is important!
6. You, or your advisors, have the knowledge needed to carry on the activity as a successful business. You have business experience. You talk to business people and maybe take a class on clowning as a business. You attend marketing classes at conventions. Show you are approaching this in a business manner.
7. You were successful in making a profit in similar activities in the past. If this is your first attempt this would not apply.
8. The activity makes a profit in some years. This is important. It helps if you make money. It proves profit motive.
9. You can expect to make a future profit from appreciation of the assets used in the activity. This would not apply to a clown business.
As you can see, some of the tests do not apply and they all seem to focus on a couple of things. Profitability and businesslike operations. Clowning is a business if you treat it as such and you must do so for taxes. And if you lose money in a given year you can use it to reduce your taxes if you have a profit motive and treat the business in a businesslike manner.. Even if you lose money in a couple of years in a row there is a presumption of profit if you can produce a profit in at least 3 of the last 5 tax years.