Ask the tax adviser
By George Saenz • Bankrate.com

May 9, 2000 -- Today, the tax adviser looks at when a business is more than a hobby and how to compute estimated taxes.

Business vs. hobby income

Dear Tax Talk:
I have earned about $17,000 this year by painting murals. However, I am not sure whether I should claim this as small-business income or hobby income. What is the difference?
M2000

Dear M2000:
I'm sorry to say that you do not have a choice on how to report income. If you make $17,000 from a hobby, then you report it as income on Form 1040, Schedule C, Profit or Loss from a Business. Of course, you can offset expenses against the income. As an artist, a lot of expenses that might create elements of personal enjoyment would probably be deductible against the income; for example, travel, admissions to galleries and museums, etc. If those expenses exceed the income you made, then you have to evaluate if the business is engaged in for profit or as a hobby.

If it's a business engaged in for profit and your expenses exceed your income, then the loss is deductible. If you continue to sustain losses annually the Internal Revenue Service may examine your return and ask you to prove that you are engaged in the activity for profit and that it is not a hobby. If the IRS determines it to be a hobby, then the losses would not be deductible.

How do you prove that it is a business and not a hobby? Well, you have to run it like a business and not a hobby. Keep good business records, advertise or publicize, and maintain dedicated and persistent efforts to develop the business. The IRS would claim it was a hobby if you don't treat it like a business and it has elements of personal enjoyment. Govern yourself accordingly.

For more on being your own boss, check out Bankrate.com's basic on this topic.

Estimated taxes and penalties

Dear Tax Talk:
If I have a gain and have paid on my estimated taxes the total amount of last year's tax bill, but have not paid the amount I owe in the quarter I have the gain, will I be assessed a penalty? What is the rule on this?
Evelyn

Dear Evelyn:
Individuals who believe they may owe tax that is not covered by withheld taxes must make estimated tax payments to avoid a penalty for underpaid tax. The penalty is equivalent to an interest charge and works out to approximately 5 to 6 percent of the underpaid tax.

An individual will be considered safe from penalty if he or she (or they, in the case of a joint return) has paid in through withholding and quarterly estimates as much tax as they owed in the preceding year, or 90 percent of the current year's tax. If you paid in last year's tax bill in full or on a quarterly basis, you won't have a penalty for not paying tax on the gain until you file your tax return on April 15 of the following year.

An exception to this rule is that you are required to pay in 108.6 percent (don't ask me why they chose this number; it has to do with government budget projections) of your 1999 tax if your 1999 adjusted gross income was more than $150,000. Estimated taxes are remitted to the IRS on Form 1040-ES. Similar rules apply to trusts and corporations.

-- Posted May 9, 2000

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