Job Related Tax Deductions

Ordinary and necessary job expenses which were not reimbursed are deductible. Ordinary and

necessary expenses reimbursed by the employer and reported as income in box 1, Form W-2, are also deductible. An ordinary expense is one that is common and accepted in the taxpayer’s line of work. A necessary expense is one that is helpful and appropriate for work. An expense does not have to be required to be considered necessary.

Tax Reporting

A taxpayer must report on his or her tax return if any of the following apply.

•    The employee claims any job-related vehicle, travel, transportation, meal, or entertainment expenses.

•    The employer reimbursed any reportable expenses.

•    The employee claims any job related expenses as a reservist, a qualified performing artist, a fee-basis state or local government official, or an individual with a disability claiming impairment-related work expenses.

Standard Mileage Rate

The business standard mileage rate for 2013 is 56.5¢ per mile.

Examples of other job expenses deductible as unreimbursed employee expenses:

•    Business bad debt.

•    Business liability insurance premiums.

•    Casualty and theft losses of property used in performing services as an employee.

•    Depreciation on a computer or cell phone required by an employer.

•   Dues to professional organizations and chambers of commerce if work related and entertainment is not one of the main purposes of the organization. Any part of dues that is for lobbying and political activities is nondeductible.

•    Education expenses related to work.

•    Job search fees to employment agencies and other costs to look for a new job in the taxpayer’s present occupation, even if the taxpayer does not find a new job.

•    Legal fees related to work.

•    Licenses and regulatory fees.

•    Lobbying expenses to influence local legislation, and other exceptions to the general rule.

•    Malpractice insurance premiums.

•    Occupational taxes.

•    Office-in-home expenses as an employee.

•    Phone charges for business use, but not the cost of basic service for the first phone line into a residence.

•    Physical examinations required by employer.

•    Protective clothing required for work, such as hard hats, safety shoes, and glasses.

•    Safety equipment needed for work.

•    Subscriptions to professional journals and trade magazines related to work.

•    Tools and supplies used for work.

•    Uniforms required by employer that are not suitable for ordinary wear.

•    Union dues and expenses.

Job Search Expenses

Expenses incurred in looking for a new job in the taxpayer’s present occupation are deductible, even if the taxpayer does not get a new job. Job search expenses are not deductible for:

•    Looking for a job in a new occupation.

•    A substantial break between the ending of the last job and looking for a new job.

•    The taxpayer looking for a job for the first time.

Uniforms and Work Clothes

The cost and upkeep of uniforms and work clothes are deductible if:

•    The taxpayer must wear them as a condition of employment, and

•    The clothes are not suitable for everyday wear.

•    It is not enough that the taxpayer wears unique or distinctive clothing on the job, or that the taxpayer does not in fact wear the work clothing away from work.

Lobbying Expenses

Expenses to influence legislation are not deductible.

Exceptions:

•    Expenses for attempting to influence the legislation of any local council or similar local government, including an Indian tribal government.

•                      Up to $2,000 per year (not counting overhead expenses) for in-house expenses to influence legislation or  communicating directly with a covered executive branch official.

•   Expenses of a professional lobbyist in the trade or business of lobbying on behalf of another person.

Residential Telephone Line

The cost of local telephone service for the first telephone line into a taxpayer’s residence is not deductible, even if it is used in a trade or business. Any added charges for business use are deductible, such as the cost of a second line, fax line, long distance, voice mail, internet service, etc.

Unclaimed Reimbursements

If a taxpayer is entitled to be reimbursed by his or her employer for job-related costs but does not put in a claim for reimbursement, the costs are not deductible.

Travel Expenses

Travel expenses are ordinary and necessary expenses incurred by a taxpayer while on temporary travel away from his or her tax home for business purposes. A taxpayer travels away from his or her tax home if the taxpayer’s business duties require an absence from home that is substantially longer than a day’s work, and the taxpayer needs sleep or rest to meet the demands of the work while away from home. The tax home includes the entire city or general area in which the taxpayer’s business is located.

Standard meal allowance. A taxpayer can substantiate meal and incidental expenses with a standard meal allowance ($46 per day from October 1, 2012 through September 30, 2013). Additional amounts may apply for certain high-cost localities, based on IRS Publication 1542, Per Diem Rates.

Lodging. Although an employer can reimburse an employee tax free for qualified lodging at per diem rates, for an employee or self-employed individual, only actual expenses are allowed for lodging.

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Interest that is Deductible

•    Home mortgage interest paid, including acquisition debt and home equity debt.

•    Points and loan origination fees to obtain a mortgage or to refinance a mortgage.

•    Investment interest paid, such as margin interest on a brokerage account.

Mortgage Insurance Premiums      

Premiums paid for acquisition indebtedness for insurance contracts after December 31, 2006 are treated as deductible mortgage insurance. The deduction is phased out for taxpayers with adjusted gross income over $100,000 ($50,000 for Married Filing Separately). The deduction is not allowed when adjusted gross income exceeds $109,000 ($54,500 Married Filing Separately).

Qualified mortgage insurance providers include the Veterans Administration, the Federal Housing Administration or Rural Housing Administration, and private mortgage insurance.

Prepaid Mortgage Insurance Premiums

For taxpayers who prepay a portion or all of the mortgage insurance premiums on a mortgage, IRS rules dictate that the prepaid amount cannot be deducted in the year paid. Instead, the amount is required to be spread out over the shorter of: • The stated term of the mortgage, or

• 84 months (7 years), beginning with the month in which the mortgage insurance was obtained.

These allocation rules do not apply to mortgage insurance provided by the Department of Veterans Affairs or Rural Housing Administration.

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Itemized Deductions for Homeowners

The IRS defines a home as any house, condominium, cooperative, mobile home, boat, or similar property that has sleeping space, toilet facilities, and cooking facilities. Some homeowners qualify for these deductions.

Real Estate Taxes   

You can deduct real estate taxes assessed on all the real estate you own. You are not limited to the tax on just one or two homes.

•    Only the amount actually paid is deductible. Don’t confuse this amount with deposits made to your mortgage escrow account.

•    Charges for trash collection, sewer, etc., are sometimes added to real estate tax bills. These amounts are not deductible as real estate taxes. 

•    Special assessments are sometimes added to real es-tate tax bills. Assessments are not necessarily deductible as real estate taxes.

Form 1098

Your lender will generally give you Form 1098, Mortgage Interest Statement, to tell you how much interest you have paid. An explanation must be attached to your tax return if the amount shown on Form 1098 is different from the deducted amount or if more than one person paid deductible mortgage interest (other than a spouse filing jointly).  If you did not receive Form 1098, you must provide the name, identifying number, and address of the interest recipient.

Home Mortgage 

A home mortgage is any loan secured by your main or second home, including first and second mortgages, home equity loans, and refinanced loans. The loan must be legally recorded, with the home as collateral for the debt. You must be legally liable to make the payments. For example, if you borrow money from your parents to make a down payment on your home, you cannot deduct the interest you pay them unless the loan is legally recorded with the home as collateral.

Refinanced Loans 

Debt that is refinanced generally retains its character as acquisition or home equity debt, up to the old loan balance.

•    Debt used to substantially improve your home is acquisition debt, even if it is refinanced home equity debt.

•    Refinanced acquisition debt that exceeds your old debt may qualify as home equity debt.

Points 

Terms such as points, loan discount, loan origination fees, etc., refer to certain charges you might pay in order to obtain a mortgage. If you pay points to borrow money, the points are deductible as prepaid interest. 

• Points are deductible over the life of your loan. Points you pay at the time of your home purchase are deductible in full.

•    Points you pay to the lender in exchange for a lower interest rate are generally shown on your closing statement. Each point charged to obtain a loan is 1% of the loan amount. For example, 2.5 points charged on a $100,000 loan equals $2,500 ($100,000 × 2.5%).

•    Fees your lender charges for specific loan services are not deductible. Examples include appraisal, notary, and document fees.

Mortgage Insurance Premiums 

Premiums paid for acquisition indebtedness for insurance contracts issued after December 31, 2006 on a first or second home are treated as deductible mortgage interest. The deduction begins to phase out when AGI exceeds $100,000 ($50,000 MFS). Qualified mortgage insurance providers include the Department of Veterans Affairs, the Federal Housing Administration, or the Rural Housing Service, and private mortgage insurance.

Medical Expense Deductions 

You may need to make home improvements in order to provide medical care for yourself, your spouse, or your dependent. Examples: (1) Lifts or elevators, (2) therapy pool for help with a specific medical condition, (3) bathroom or countertop modifications to accommodate a person who is disabled, (4) ramps, handrails, support or grab bars, (5) modifications to halls and doorways.

An expense may generate a medical deduction to the extent the expense does not result in an increase to the home’s value. Not every expense results in such an increase.

Operation and Upkeep 

Amounts you pay to operate and maintain a medically related home improvement qualify as medical expenses, if the main reason is for medical care. This is true even if only part or none of the asset cost qualified for a deduction.

Casualty and Theft Losses 

If your home is damaged or destroyed due to an identifiable event that is sudden, unexpected, and unusual, you may have a casualty loss. Losses are calculated on Form 4684, Casualties and Thefts, and carried to Schedule A, Itemized Deductions.

Business Use of the Home 

If you use a home office as an employee, you may be able to claim a miscellaneous itemized deduction for the business use of your home.

•    You must use your home office for the convenience of your employer. 

•    You may not rent your home office to your employer.

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Education Expenses

Expenses for education are deductible even if the education leads to a degree, if it meets at least one of the following tests.

1)  The education maintains or improves skills required for the taxpayer’s present work.

2)  The education is required by the taxpayer’s employer or by law.

Exception: Education is not deductible, even though one or both of the above tests are met, if the education:

1)  Is needed to meet the minimum educational requirements to qualify for the taxpayer’s line of work, or

Seal of the United States Department of Education (Photo credit: Wikipedia)

2)  Will lead the taxpayer to qualify for a new line of work. This is true even if the taxpayer does not intend to enter that line of work.

Education Required By Employer or By Law

Once minimum educational requirements are met for a job, an employer or the law may require additional education. This additional education is deductible if all the following requirements are met.

•   It is required to keep the taxpayer’s present salary, status, or job.

•    The requirement serves a business purpose of the employer.

•    The education is not part of a program that will qualify the taxpayer for a new trade or business.

If a taxpayer receives more education than required by an employer or by law, the additional education can qualify as work-related education only if it maintains or improves skills required for a taxpayer’s present line of work. This could include refresher courses, courses on current developments, and academic or vocational courses.

Casualty and Theft Loss Itemized Deductions

Casualty Loss

A casualty loss is the damage, destruction, or loss of property resulting from an identifiable event. The identifiable event must be:

•    Sudden, not gradual or progressive.

•    Unexpected, not ordinarily anticipated or intended.

•    Unusual, not a day-to-day occurrence or typical of the taxpayer’s activity.      

Theft Loss

A theft is the taking and removing of money or property with the intent to deprive the owner of it. The taking of property must be:

•    Illegal under the law of the state where it occurred.

•    Done with criminal intent.

Deductible Amount of Losses

A non business casualty or theft loss is the lesser of the taxpayer’s basis in the property damaged or destroyed, or the reduction in fair market value due to the casualty or theft. From this amount, any insurance or other reimbursement received, or that could have been received, if the taxpayer chose not to file a claim is subtracted.

The casualty or theft loss is then reduced by $100 per event when computing the deductible amount. Multiple items lost in a single event result in only one $100 reduction. The total of all casualty and theft losses from all events during the year is further reduced by 10% of the taxpayer’s adjusted gross income.

Criminal Fraud

Victims of criminal fraud or embezzlement related to a transaction entered into for profit are allowed to deduct the theft loss as a miscellaneous itemized deduction not subject to the 2% adjusted gross income limitation. The deduction is also not subject to any other theft loss or itemized deduction reductions or limitations.

Insurance

Losses are not deductible to the extent they are reimbursed by insurance. If property is covered by insurance, a timely insurance claim for reimbursement must be filed or the deduction is not allowed. The part of the loss not covered by insurance is deductible. If a casualty loss is claimed in one year, and in a later year the taxpayer receives reimbursement for the loss, the deductible loss is not recomputed for the taxable year in which the deduction was taken. Rather, the reimbursement amount is included in income in the taxable year in which it was received.

Insurance proceeds used for living expenses are not reimbursements for damages so amounts paid for normal living expenses are generally taxable. However, payments to cover a temporary increase in living expenses are excluded from income.

Note: If the casualty occurs in a federally declared disaster area, none of the insurance payments are taxable.

Gain on Reimbursement

If insurance or other reimbursement is more than the basis in the property damaged or destroyed, the reimbursement is a gain. The gain is taxable if a taxpayer does not use the proceeds to purchase replacement property similar or related in service and use. The gain is postponed if:

•    The taxpayer purchases property that is similar or related to it in service or use within two years of the end of the first tax year in which any part of the gain is realized (or acquires at least 80% of a corporation owning such property), and

•    The cost of the replacement property is equal to or more than the reimbursement received for the damaged, destroyed, or stolen property.

If the replacement property costs less than the reimbursement, gain is recognized to the extent the reimbursement exceeds the cost of the replacement property.

Federally-Declared Disaster Areas

A federally-declared disaster is a disaster determined by the President to warrant federal government assistance. The 10% of adjusted gross income limitation for casualty losses also applies to the portion of loss due to a net disaster loss.

Year of Deduction for a Federally-Declared Disaster Loss A taxpayer may elect to deduct a loss in a federally-declared disaster area in the tax year immediately prior to the disaster year. The return (or amended return) claiming the loss must be filed by the later of: The due date for filing the original return (without extensions) for the tax year in which the disaster occurred, or The due date for filing the original return (including extensions) for the tax year immediately prior to the tax year in which the disaster occurred. Items to include on the tax return include the date of the disaster and the city, town, county, and state in which the damaged or destroyed property was located.

Disaster Relief

Food, medical supplies, and other forms of assistance received do not reduce the casualty loss, unless they are replacements for lost or destroyed property. Qualified disaster relief payments received for expenses incurred as a result of a federally declared disaster are not taxable income.

Cash Gifts for Disaster Victims

If a taxpayer receives a cash gift as a disaster victim (such as gifts from relatives and neighbors) and there are no limits on how the taxpayer can use the money, the gift is excluded from income. The casualty loss is not reduced by the cash gift. This is true even if the cash gift is used to help pay for repairs to property damaged in the disaster.

When to Deduct a Casualty or Theft Loss

Casualty or theft losses are deductible in the year the casualty occurred or the theft was discovered. If it is uncertain whether insurance will reimburse all or a portion of the loss, do not deduct the amounts of the loss in question until the tax year when it is reasonably certain the loss will not be reimbursed.

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Identity Theft and Your Taxes

Your identity and money can be stolen in a tax-related scam via email (“phishing”), fax, phone, or letters. Some recent examples of identity theft scams are:

•    Refund scam. A bogus email, claiming to come from the IRS, tells you that you are eligible to receive a tax refund for a given amount if you just follow the instructions in the email.

•    Inherited funds, lottery winnings, and cash consignment scams. A bogus email, claiming to come from the U.S. Department of the Treasury, notifies you that you will receive millions of dollars if you follow the instructions in the email. This may be a multi-step scheme that includes instructions for you to deposit taxes on the funds before they can be paid out or the issuance of a phony check on which you must pay 10% tax before the check can be deposited.

•    EFTPS scam. A bogus email, claiming to come from the IRS, contains a realistic-looking screenshot of the IRS website with a message about fraud attempts regarding your bank account. The email states that the bank account can be unblocked if you just click a link and provide information.

•    EIN scam. A bogus fax, claiming to be from the IRS, informs you that you have failed to submit required bank account details. You are asked to fax back a form that requests your EIN, bank information, and officer signatures.

Notify the IRS

If you receive a tax-related phishing email, do not click on the links or open any attachments. Forward the email to phishing@irs.gov or call the IRS at 800-829-1040.

How the IRS Contacts Taxpayers

•    The IRS will never initiate contact with you by email or any social media tools to request personal or financial information.

•    It is unusual for the IRS to initiate contact by fax or phone call. You can call the IRS at 800-829-1040 to verify that an unexpected fax or phone call is legitimate.

Fraudulent Tax Returns

An identity thief might use your Social Security number to fraudulently file a tax return and claim a refund. You could be completely unaware that your identity has been stolen until your return is rejected for e-filing or you get an IRS notice or letter.

Rejected e-File

Your electronically filed return is rejected because the Social Security number belonging to you, your spouse, or a dependent has already been used on a tax return.

•    This situation can occur because of a mistyped num-ber or dispute about claiming a dependency exemption. Such cases do not necessarily indicate identity theft.

•    If your return has been rejected because of a previ-ously used Social Security number, it cannot be e-filed. You must file a paper return.

IRS Notice

You receive an IRS notice or letter stating that:

•    More than one return was filed in your name for the year,

•    You have a balance due, refund offset, or initiation of collection action for a year when you did not file a return, or  

•    IRS records indicate that you received wages from an employer you didn’t work for.

You should respond immediately to the name and phone number printed on the IRS notice or letter. You will be asked to complete Form 14039, Identity Theft Affidavit, and provide identifying information.

IRS Identity Protection Specialized

Unit (IPSU)

If you believe there is a risk of identity theft due to lost or stolen personal information, contact the IPSU immediately so the agency can take action to secure your tax account. • Call 800-908-4490.

• You will be asked to complete Form 14039, Identity Theft Affidavit.

Form 14039, Identity Theft Affidavit     

Form 14039 has two purposes.

1) Informs the IRS you are an actual or potential victim of identity theft that has or could affect your tax account.

2) Requests that the IRS mark your account to identify any questionable activity.

You must provide details of the actual or potential identity theft situation, tax years impacted (if known), address and other contact information, and a photocopy of valid government-issued identification.

Identity Protection PIN (IP PIN) Program

If the IPSU determines that you do have a tax-related identity theft problem, the IPSU will research your account, identify the IRS business unit handling the case, and monitor the case to ensure it is being handled in a timely manner.

•    The IRS may issue you an Identity Protection PIN (IP PIN). The computer-generated IP PIN has six digits and is specific to the tax year for which it was provided.

•    The IRS issues IP PINs to allow a legitimate taxpay-er’s return to bypass the identity theft filter, prevent fraudulent returns from being processed, and minimize taxpayer burden associated with potential delays when a return fails one or more of the identity theft filters.

•    A new IP PIN will be issued to you every filing season as long as the identity theft indicator remains on your account.

Using an IP PIN

You will receive an IRS notice in the mail containing the single-use six-digit PIN. The IRS does use email or fax to notify taxpayers of an IP PIN.

•    All six digits must be input on your Form 1040 in the space to the right of the spouse’s occupation line. Use of the IP PIN on the return acts as an authenticator to validate you as the legitimate owner of the Social Security number on the tax return.

•    If you lose or misplace the IP PIN letter, the IRS may issue a replacement IP PIN for the year. You may file a paper return without the IP PIN, but processing and refunds may be significantly delayed.

Surprise IP PIN Letter

The IRS has been known to mail an IP PIN letter to a taxpayer who was previously unaware of a potential tax-related identity theft problem. If you receive an unexpected IP PIN letter, you can call the IPSU phone number (800-908-4490) to verify that the IP PIN letter is legitimate.

Identity Theft Outside the Tax System

You may be at increased risk for tax-related identity theft for various reasons.

•    You have lost or had stolen a wallet, purse, or docu-ments that include sensitive identifying information.

•    You have noted questionable credit card activity or credit report information.

•    You have fallen victim to an identity theft scam.

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Do You Have Household Employees?

If you have a household employee, you may need to withold and pay Social Security and Medicare taxes (FICA), pay federal unemployment tax (FUTA), or both.

Workers Who Are Household Employees

A household employee is an employee hired to do household work. The worker is an employee if you can control both what and how work is done. It does not matter whether the work is full time or part time or that the worker was hired through an agency or association. It also does not matter whether the worker is paid on an hourly, daily, or weekly basis, or by the job.

Note: If the worker usually provides his or her own work tools and offers services to the general public, he or she is an independent contractor and not a household employee.

Household Workers

Some examples of workers who do household work include the following.

•    Babysitters    • Housekeepers

•    Caretakers     • Maids

•    Domestic workers       • Nannies

•    Drivers          • Private nurses

•    Health aides • Yard workers

•    House cleaning workers

Workers Who Are Not Household Employees

If only the worker can control how the work is done, the worker is not a household employee but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public as an independent business. A worker who performs child care services in his or her home generally is not a household employee. If an agency provides the worker and controls what work is done, the worker is not a household employee.

Household Employment Taxes  

Taxpayers with household employees must file Schedule H, Household Employment Taxes, with their Form 1040 to report FICA (Social Security and Medicare) tax, FUTA (federal unemployment) tax, and federal income tax withholding (if any).

Form W-2 must be filed for each household employee who was paid Social Security or Medicare wages of $1,800 or more, or wages of any amount if federal income tax was withheld.

Taxpayers who are required to file Schedule H with their 2013 individual tax returns must obtain an Employer Identification Number (EIN) by January 31, 2014.

FICA

The Social Security tax pays for old-age, survivors, and disability benefits for workers and their families. The Medicare tax pays for hospital insurance. Both the employer and the household employee may owe Social Security and Medicare taxes. For 2013, the employer share is 7.65% (6.2% for Social Security tax and 1.45% for Medicare tax) of the employee’s FICA wages. For 2013, the employee’s share is 7.65% (6.2% for Social Security tax and 1.45% for Medicare tax). The employer is responsible for remitting both the employee’s and employer’s share of the taxes. Typically, the employee’s share is withheld from the employee’s wages and submitted with the employer’s payment.

Figuring FICA taxes

FICA taxes on Social Security and Medicare wages paid to household employees are figured by the employer.

If you pay your household employee cash wages of $1,800 or more in 2013, all cash wages you pay to that employee in 2013, up to $113,700, (regardless of when the wages were earned) are Social Security wages and all cash wages are Medicare wages. However, any noncash wages paid do not count as FICA wages.

If you pay the employee less than $1,800 in cash wages in 2013, none of the wages are FICA wages and neither you nor the employee will owe FICA taxes on those wages.

Cash Wages

Cash wages include wages paid by check, money order, etc. Cash wages do not include the value of food, lodging, clothing, and other noncash items you give your household employee. However, cash you give your employee in place of these items is included in cash wages.

Wages Not Counted

Do not count wages paid to any of the following individuals as FICA wages.

1)  Your spouse.

2)  Your child who is under age 21.

3)  Your parent. Exception: Count these wages if your parent cares for your child who is either under age 18 or has a physical or mental condition that requires personal care by an adult, and your marital status is either divorced, widowed, or living with a spouse whose physical or mental condition prevents him or her from caring for your child.

4)  An employee under age 18 at any time during the year. Exception: Count these wages if providing household services is the employee’s principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.

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Hobby or Business?

If an individual, partnership, estate, trust, or an S corporation engages in an activity that is not conducted as a for-profit business, deductions are limited to the amount of income from the activity. This rule does not apply to corporations, other than S corporations. If an activity is considered a for-profit business, deductions can exceed income, allowing the resulting loss to offset other income.  

Determination

In determining whether an activity is a hobby or a business, all facts and circumstances are taken into account. No one factor can make the determination. The following list is not intended to be all inclusive.

1)  Manner in which the taxpayer carries on the activity. Factors that may indicate a business include maintaining complete and accurate books and records, carrying on the activity substantially similar to other profitable activities of the same nature, and changing operating methods and techniques to improve profitability.

2)  The expertise of the taxpayer or his or her advisors. Factors that may indicate a business include knowledge of the taxpayer, or consultation with those who are knowledgeable about a particular industry, then using that knowledge to try and make a profit.

3)  The time and effort expended by the taxpayer in carrying on the activity. Factors that may indicate a business include spending a lot of time and effort in the activity, particularly if the activity does not have substantial personal or recreational aspects.  Taking time away from another occupation may also indicate a profit motive. Spending little time will not be counted against the taxpayer if qualified employees are hired to carry on the activity.

4)  Expectation that assets used in the activity may appreciate in value. Even if no profit is made from operations, if the value of land or other assets in the activity appreciate so that an overall profit is made from a sale, the activity may be considered a business.

5)  The success of the taxpayer in carrying on other similar or dissimilar activities. If the taxpayer was successful in the past turning an unprofitable venture into a profitable venture, the current activity may be a business even if it has not yet made a profit.

6)  The taxpayer’s history of income or losses with respect to the activity. Early losses during start-up will not count against the taxpayer, but continued losses after the customary start-up stage that are not explainable may indicate a hobby. Losses sustained due to unforeseen circumstances, such as casualty or thefts beyond the taxpayer’s control, will not count against the taxpayer. Any series of profitable years are strong evidence the activity is a business.

7)  The amount of occasional profits, if any, which are earned. The amount of profits in relation to the amount of losses, and in relation to the taxpayer’s investment in the activity, may indicate intent. An occasional small profit one year, mixed with large losses in other years or large taxpayer investments, may indicate the activity is a hobby. Substantial occasional profits mixed with frequent small losses or investment may indicate a business. An opportunity to earn substantial ultimate profits in a highly speculative venture also indicates a profit motive.

8)  The financial status of the taxpayer. If the taxpayer does not have substantial income or capital from other sources, the taxpayer may have a profit motive. If the taxpayer has substantial income from other sources, and losses from the activity in question generate substantial tax benefits, the taxpayer may not have a profit motive.

9)  Elements of personal pleasure or recreation. Where there are recreational or personal elements involved with the activity, a lack of profits may indicate a hobby. On the other hand, a lack of any appeal in the activity other than possible profits indicates a profit motive. It is not necessary that the sole purpose for engaging in an activity is to make a profit. The availability of other investments that might produce a higher rate of return will not count against the taxpayer. The fact that a taxpayer derives personal pleasure in the activity is not sufficient in itself to classify the activity as a hobby if other factors indicate the activity is a business.

Presumption of Profit

IRS rules state that if an activity is profitable in three of the last five tax years, including the current year, the presumption is it is carried on for profit, and the hobby loss limitations do not apply. If the activity consists primarily of breeding, training, showing, or racing horses, the IRS will presume it is carried on for profit if a profit is produced in at least two of the last seven tax years, including the current year.

Reporting Hobby Income and Expenses

Occasional profits from hobby activities are not subject to self-employment tax, and losses from hobby activities cannot be used to offset other income.

Who Must Pay Estimated Tax

If you are filing as a sole proprietor, partner, S corporation shareholder, and/or a self-employed individual, you generally have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your return.

If you owed additional tax for the prior year (did not have enough withheld by employer), you may have to pay estimated tax for the current year.   

General rule. In most cases, you must pay estimated tax for the current year if both of the following apply.

1)  You expect to owe at least $1,000 in tax for the current year, after subtracting withholding and refundable

credits, and

2)  You expect your withholding and refundable credits to be less than the smaller of:

a)  90% of the tax to be shown on your current year tax return, or

a)  100% of the tax shown on your previous year’s tax return, if your previous year’s return covered all 12 months.

Note: The percentage amounts may be different if you are a farmer, fisherman, or higher-income taxpayer.

Who Does Not Have to Pay Estimated Tax

If you receive salaries and wages, you can avoid having to pay estimated tax by asking your employer to withhold more tax from your earnings. To do this, file a new Form W-4 with your employer. There is a special line on Form W-4 for you to enter the additional amount you want your employer to withhold.

You do not have to pay estimated tax for the current year if you meet all three of the following conditions.
• You had no tax liability for the prior year,

•    You were a U.S. citizen or resident for the whole year, and

•    Your prior tax year covered a 12 month period.

You had no tax liability for the prior year if your total tax was zero or you did not have to file an income tax return.

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Estimated Taxes

The federal income tax is a pay-as-you-go tax. You must pay the tax as you earn or receive income during the year. There are two ways to pay as you go, either by employer withholding or estimated tax payments.    

Employer withholding. If you are an employee, your employer generally withholds income tax from your pay. In addition, tax may be withheld from certain other income such as pensions, bonuses, commissions, and gambling winnings. If all of your income will be subject to income tax withholding, you probably do not need to pay estimated tax. Events during the year may change your marital status or exemptions, adjustments, deductions, or credits you expect to claim on your tax return. When this happens, you should complete a new Form W-4, Employee’s Withholding Allowance Certificate, so that the appropriate amount of tax is withheld.

Estimated tax. Estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self-employment, interest, dividends, alimony, rents, gains from the sale of assets, prizes and awards. You also may have to pay estimated tax if the amount of income tax being withheld from your salary, pension, or other income is not enough.

Estimated tax is used to pay not only income tax, but selfemployment tax and alternative minimum tax as well. If you do not pay enough by the due date of each quarterly payment period you may be charged a penalty even if you are due a refund when you file your tax return.

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