Woodworking business and the IRS


I've just started a part-time woodworking business this past year in part to write-off the costs of building a barn workshop. I don't plan to be all that active in the business at first, but expect to pick the business up when I retire in about 10 years. I don't intend to make a fortune at this and I don't expect to make a profit the first few years.
The IRS has certain rules in what constitutes a business versus a hobby. You must have an active plan to make a profit and always be in the process of marketing yourself. Has anyone had a similar experience with the IRS, good or bad. I don't want any suprises down the road when my significant deduction is denied due to a hobby designation.
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Many people form businesses to avoid paying sales taxes and to be able to write off expenses. IIRC you do have to start showing a profit within a few years of forming the business. Naturally if you are making a profit you can remain in business. If you continue to loose money and remain open that sends a red flag. They ask, how can he remain in business and loose money every year. Remember the saying, Pigs get fat and Hogs go to slaughter. Check with a CPA to be safe.
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When I first ventured out of the warm embrace academia into the cold, bitterness of the Real World and got my first Big Boy job it was as the chief Unix Geek for a small ISP, as a contractor. For tax purposes I got a business liscense and ran my relationship with my employer as one business providing services to another. I did the bulk of my work onsite, on equipment and in space they provided, however a portion of my work was done from home.
Specifically I did all my invoicing/accounting at home, any odd after-hours only maintenance I could do remotely and any after hours emergencies were done from home. All of this work was done on my own computers, from my own internet connection. Since being a computer geek was (and still is) a hobby in addition to being a job there was a lot of crossover between the equipment usage, very similar to the situation you've described.
What I had to do vis-a-vis the IRS was to only deduct the percentage of my dual-use geek expenses that were used in conjuction with my little business and be able to justify/document the perctage deducted. I never did feel comfortable doing this all by my lonesome so for the two tax-years I was working this way I dropped the $100 a session with a tax planner cost me to get some help coming up with and documenting the deductions I was taking. I was never questioned by the IRS about any of this. This was in 2001-2002.
More recently I've helped an artist friend, who hocks her wares on the internet from her apartment, with her taxes doing the same percentage game with her rent, art supply and internet costs. She was never questioned either of the two years I helped her.
Still given the much larger sums you're likely be trying to deduct I suggest talking to an expert before you start laying out cash. Depending on how large your initial capital expenditures are going to be it may be worth your while to incorporate as an LLC and have the business purchase the equipment/workshop and reap the tax benefits in stages either by amortizing the expense over several years or treating it like a capital investment and counting the depreciation of those assets against your profits over the years. Or some combination of the two.
Talk to a CPA, it'll cost ya maybe a few hundred for their time to get all this setup but it'll save an order of magnitude more in headaches down the road if something goes awry.
Cheers,
Josh
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MrAnderson wrote:

The IRS has also changed the rules for what can be deducted as "office space" in a part time business. Unless your barn workshop is strictly used for business purposes I'd check with a qualified accountant before attempting to write off the cost of the building.
--
Jack Novak
Buffalo, NY - USA
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First of all, in order to be able to 'write off' anything, there has to be a taxable income to write off against.
Whatever you are claiming to be an expense to your business, like rent, you'll have to declare that rent (that your business pays) as income because you are the owner of the building. Maintenance deductions become complex as well.
Get some help from a creative accountant/tax consultant. A seemingly small move today can save your butt a few years down the road. The revenuers live by one rule: ignorance of the law is NOT a defence.
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Robatoy wrote:

You need to talk to an accountant that is familiar with tax law.
The building may be considered a capital asset which you cannot write off your taxes by depreciation.
There may be ways to offset some of your tool costs and utility costs and perhaps property taxes and maybe a mortgage if you financed the building.
All deductions though come off the taxable income from the business. You may be able to claim more if you have another income source but be sure your accountant gets it right.
You will need a business registration and submit monthly and yearly sales tax returns. That is if you sell retail.
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I am a tax consultant(sorry no free advice),You really do need to spend a little money and consult a tax qualified advisor. He/she can answers all your questions and may be able to help you plan a legal and painless way to your goal. I have been doing this for more than twenty five years and there are some good ways to reach your goal but beware there are pitfalls and there is a lot of myth.
len Allied tax service
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You might want to go to misc.taxes.moderated. There are some helpful people there, though it is very slow because it is moderated.
I sell a few pieces now and then, but I don't claim anything other than exactly what goes into the sold work. I also never abuse my tax-free purchasing. Odds are they will never even look at your return, but If they catch you doing it wrong they will come down on you with the wrath of God; and for a few hundred (or even thousand) dollars I just don't need that. I wouldn't even think about claiming your workshop; in fact I just expanded mine and claimed zero. There isn't much excuse for not making money in a part-time woodworking business. Your only real expenses, labor and materials, are totally variable. If you aren't doing enough business to pay for your tools, then you aren't a business; at least that is how I expect the IRS would look at it.
Have fun.
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MrAnderson wrote:

One thing I would add to the above responses (which are all valid) is to keep separate books and records. Even a separate bank account would be good. Don't comingle monies. Finally, really treat the venture as a separate entity.
Dave
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EXCELLENT suggestion.
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One other thing to think of--Insurance.
Your homeowner's insurance covers your hobby tools. But, if it's a business, it may not.
You'll never hear a peep from the insurance company, but if there is a loss, they are smart enuf to check and see if you have been claiming that this was a business, which may be enuf of a material non-disclosure to void your claim.
Better check that aspect out too.
Walt C

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Many insurance companies have a *small* amount of insurance for home-based business equipment that's available as a rider on your HO policy.
The downside is that it probably wouldn't cover a large theft. It's usually around 5k, in my experience.
Of course, you would want to let them know you have a hb business *before* a loss. Otherwise, they have the right to deny coverage. That's not the sort of thing you want to find out after the fact.
jc
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Do check with your Insurance company. Some will freak out if they find out you have a wood shop and cancel your home owners policy. Some will cover only a small portion of a wood shop ($500). Some will only cover if the shop is detatched. They all want to see a dust collector of some sort. You should have a flamable liquids cabinet of some sort. You should have smoke detectors (Fine Woodworking did an article about this a year or so ago, and said that a heat detector works better). It isn't hard to have no profit for several years while you are building a business. Intent to make a profit is important .Also, when you do eventually move, the part of the home that has been improved or built for business is taxed differently than the rest of the house (at a higher rate). I think that you have to stop using it for 2 years in order for it to be taxed as part of the house. Do check with your CPA robo hippy
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And some may even refuse to insure you. When I went to my insurance company having had 10 years of claims free home insurance, they refused to insure me for my technical writing business citing that I would be more prone to being sued than an average company. I dumped them altogether and found someone else.
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Hmm... last time this came up with my tax preparer/bookeeper, she told me that the IRS considered any small business that loses money for more than 3 years a hobby. Especially if it is not your livelihood, not your job, not the source of income that pays your bills, but more just a way to write off your purchases while building up your tool collection.
Imagine this: Hey, I bought all those tools because I was gonna be a full time woodworker. Then the old lady got pregnant got pregnant again, and we needed braces for our oldest, so it just didn't work out. Thanks for letting me have all those exemptions and deduction; it worked out great! Especially since I never really got around to starting the biz!
Anyone can tell you anything. I have been self employed for about 25 years and many of my fellow contractors have been pretty damn smarmy until their first, full audit. Nothing like watching an audit agent (usually someone that has college level bookkeeping and couldn't pass the license requirements for CPA exams) simply disallow a legitimate dedcution out of hand. It will make your eyeballs burst from the heavy handed bullying.
I have also been audited by some really nice, knowledgeable people that don't even finish the review. Things look good, professionally prepared, and they were just checking to make sure we were doing the things we needed to do.
STAY AWAY from the bar stool experts, the know it alls that read the business section, and the guys that feel like they are pretty slick at preparing their own returns. Not getting caught by the IRS doesn't mean you are doing anything at all right. It just means you haven't been caught. No matter who does your taxes, NO return will stand a full audit if you get a jerk auditor.
Best advice you have gotten here: go see a professional, someone that specializes in construction. They will know about all the pitfalls that beginning contractors/woodworkers fall into.
Robert
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what he said (below). Agood accountant will save you tons of grief (and penalties) in the long run. I had my first audit shortly after my ex filed for divorce (she called the IRS and told them I was cooking the books). I got lucky (I guess) and got a really nice auditor. He went over the books, found a couple of things he thought were a bit out of bounds (my heating bills were really higg), and asked to see receipts. He also wanted to see the office part of the business, which was in the house. My ex wouldn't let him into the house to see the office or look at the receipts (this was far enough into the divorce that she had the house, but hadn't been forced to turn over my business docs yet). The auditor really needed to see them to do his job (I had taken the home office deduction, and he was supposed to check square footage). He offered to haul my ex into federal court for obstruction of justice (I declined for some reason). In the end, he took a look around the shop, and decided that the heating costs weren't so crazy after all (the shop was a 200+ year old barn, and after spending about an hour in it doing the audit, he was pretty cold, even though the heater was blowing full blast), and decided to skip the home office inspection. He stated that he fact that my books had all been prepared by a professional accountant, and that the records were fully itemized made it pretty clear that I if there were any errors, they were small. He also pointed out some deduction I hadn't taken, and said that the missed deductions probably ballanced any shortages..... Of course, he also pointed out that the fact that the initial report came from an ex that was clearly just trying to cause grief made a difference too.....
Bottom line: an accountant is cheap (mine costs about $300 a year) insurance.... -_JD

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As others have mentioned, there are numerous things to beware of:
Your homeowner's insurance may not give you adequate coverage. Your local utility providers (like power and telco) might want to charge you higher business rates.
I think the IRS guideline is that they expect a legitimate business to make a profit 3 out of 5 years (but of course if you can document bona fide business expenses and it's really your source of income you won't have problems with legitimacy).
You don't have to go to the trouble of incorporating -- a local DBA registration is probably sufficient. But you will have to do the state and federal paperwork on your income for tax purposes. Some states may require you to file your sales tax reports bi-weekly even if they're zero. You have to deduct social security, medicare, and withholding tax, and issue yourself a W2 or 1099 at the end of the year.
If you're buying depreciable assets, you may not be able to deduct them all at once. You'll have to run a depreciation schedule.
Is it still worthwhile? You might not want to make the business official until you're actually making enough money to offset all these extra burdens.
MrAnderson wrote:

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Mike,
Not meant as a criticism, but if you are not incorporated, ie operating as a sole proprietorship, you do not need to issue a W-2 or Form 1099 to yourself. You simply report the business on your personal return as a Schedule C. You would not withhold any taxes on yourself.
You would only need the Forms W-2 and 1099 if you are paying others.
Ed
Mike Berger wrote:

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Thanks everyone for your knowledgeable & helpful replies.
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That's true -- and there's a handy IRS guide for sole proprieterships. However, you may still have to pay self-employment tax, social security, and whatever the state requires.
Ed Gallagher wrote:

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