Do any "hobbyist" knife makers understand the US tax code?

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matto6

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OK bladeforums may seem like a strange place to ask for tax advice, but I can't be the only person making knives to have this question.

In 2018, the US IRS declared that a "hobbyist" cannot deduct their expenses, and thus must pay tax on all income. The ramifications of this seem completely insane, and I'm hoping I'm missing something basic.

Does this mean that if I buy a piece of steel for $10, make a knife out of it, and sell it for $10 that I still have to pay tax even though I made zero profit? That would mean I lost $3.70-ish by trying to give away a knife for the cost of materials.

Can this possibly be correct? Or am I misunderstanding? Is there a way to consider the payment a form of "reimbursement" that is non-taxable?

My reason for asking is that I am just starting to make knives, and while I am learning I want to essentially give them away, but get reimbursed for the cost of the materials and shipping. From my reading of the tax law there's no way to do that. And recall that Payal reports income to the IRS so advising me to just not report it is not good advice!

Has anyone else figured out how this rule actually works?
 
Yep. Hobby is black market. They want to kill it. Legalize your work. Talk to someone with knowledge about it. Try searching to legalize for donations, sole proprietorship and similar. I'm in EU and it's even tougher here. I went directly to LLC. Just keep the numbers right.
 
I know nothing about taxes, so I am certainly wrong, but could you have the person buy the materials and send them to you to turn into a knife? If that is okay, then can you sell them the materials for what you paid for them, then turn them into a knife?
 
"If a taxpayer receives income for an activity that they don’t carry out to make a profit, the expenses they pay for the activity are miscellaneous itemized deductions and can no longer be deducted. The taxpayer must still report the income they receive on Schedule 1, Form 1040, line 21."

The above is copied & pasted directly from the IRS website article:

Tips for taxpayers who make money from a hobby​


I'd direct link it for you, but the IRS doesn't contribute to this site....
 
matto6 said:
Right. I have the option of starting an LLC. But they have rules on that, like showing that you make regular profits, etc.
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AFAIK, (and I'm not a tax expert), you have several years to show profit. If you won't you can kill the LLC.
 
Bühlmann said:
"If a taxpayer receives income for an activity that they don’t carry out to make a profit, the expenses they pay for the activity are miscellaneous itemized deductions and can no longer be deducted. The taxpayer must still report the income they receive on Schedule 1, Form 1040, line 21."

The above is copied & pasted directly from the IRS website article:

Tips for taxpayers who make money from a hobby​


I'd direct link it for you, but the IRS doesn't contribute to this site....
Click to expand...
The weird thing is that I can buy an item (like a knife) for $100 and later sell it for $100. That's not considered income or capital gain because I broke even or lost money. I can deduct the cost of an item I buy an resell.

But if I buy a piece of steel for $100, sharpen the edge, and sell it as a knife for $100, I have to pay $37 tax.
 
Sean Yaw said:
I know nothing about taxes, so I am certainly wrong, but could you have the person buy the materials and send them to you to turn into a knife? If that is okay, then can you sell them the materials for what you paid for them, then turn them into a knife?
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That's where it gets blurry.

I'm not sure how to "sell them the materials for what you paid for them" without that being considered income.
 
Here is the basic truth:
The IRS doesn't care about the average hobby knifemaker.
1) The IRS wouldn't know if you sold a knife or not unless you are making tens of thousands from the sales.
2) Your 10 knives that you sold for $1000 last year would gain them maybe $100 in taxes. It would cost thousands to peruse that debt, so they will ignore it.
3) If you make it a business and deduct all the materials, supplies, equipment purchase and depreciation, etc., it will likely be a big loss. After three or four years, they will declare it a hobby and say not to file a schedule C with your taxes.

They did that with me many years ago. My accountant said to just make my knives and enjoy what little they returned. Since it was a loss on paper, there was nothing the IRS cared to do about it.
My accountant told me to keep a box and drop all receipts for materials, show travel, equipment, supplies, show expenses, etc. He also said to keep track of what I sold. If the IRS ever wanted to argue the point or audit me, then I would just declare it was a business again and deduct the loss from my gross income ... lowering my taxes. The IRS would then say to forget about it.
4) There are millionaires who dodge the system and pay no taxes. The IRS spends time checking on them, not little guys who make nothing on knives.

Now that I am retiring, I will make a new LLC that includes all my crafts. I will keep good books, and this will lower my gross income from retirement to lessen my taxes. As a small business run by a retired person, the fact that the business is not profitable will not likely cause them to tell me to stop filing a schedule C anymore.
 
So, I evaluated this for a few of my hobby's (bee keeping, knives, beef cattle). I used to just give friends and family the product at cost but the hobby IRS regs makes it not worth it. I gave up beef and just give away knives and honey now to keep the IRS out of my business. I would rather give items away than have the IRS more involved in my life. If you start doing this people will inevitably share their hobbies with you also so it all evens out with the monetary transaction.

My taxes are already too complicated, and I don't need the headache "hobby income" on my taxes.
 
Stacy E. Apelt - Bladesmith said:
the fact that the business is not profitable will not likely cause them to tell me to stop filing a schedule C anymore.
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Thanks Stacy.

My concern is that once this happens (they tell you to stop filing the Schedule C) that makes you a hobbyist, and it also means you now owe tax on everything you've brought in for the last 5 years. No?
 
matto6 said:
The weird thing is that I can buy an item (like a knife) for $100 and later sell it for $100. That's not considered income or capital gain because I broke even or lost money. I can deduct the cost of an item I buy an resell.

But if I buy a piece of steel for $100, sharpen the edge, and sell it as a knife for $100, I have to pay $37 tax.
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This county's genesis was in rebellion and eventually revolution stemming from unfair taxation. 250 years later we are in a situation not unlike the first. You can either agonize over the minutia of an agency's arbitrary will, or you can choose liberty and enjoy your hobby as a free man. If the day comes where you hear the black jackboots clicking up your driveway, you'll have another choice to make. Whether you wish to live under that cloud of oppression or not is your decision to make.

Now let's see some pics of those (potentially) outlaw knives!
 
In a nutshell, if you sell your work, that sale is taxable income... whether you make enough to cover your expenses or not. You get to declare, ONLY if you pay into the system.

I'm betting this is to prevent folks from deducting expenses for their hobby, without paying the government taxes on the money they receive from said, hobby.

I'm a Canadian but i suspect it is similar. If you pay income tax, you are entitled to write-off deductions on the materials you buy. Charging sales tax doesn't need to happen, if you make under $30K/annually but you can't deduct the sales tax on expenses unless you are also charging sales tax to your customer. No source of income is immune. Even yard/garage sales are taxable income! I don't know how it works in the States.

It sounds like you want to make stuff and only sell at a price that covers your expenses, without having to pay income tax or charge sales tax? If so, there might be a way to get out of charging sales tax(a nightmare of state/county tax schedules to adhere to, over there) but you cannot avoid having to pay income taxes, without "dodging" them. The fact that you only want to break even, does not matter.

So yes... if you sell a $10 bar of steel for $10, you will pay tax on the $10 of income and lose money... not all, but some. My advice, is to tell you to charge more for your work and pay income tax, or accept that you cannot charge or deduct anything.
 
Rick Marchand said:
So yes... if you sell a $10 bar of steel for $10, you will pay tax on the $10 of income and lose money... not all, but some. My advice, is to tell you to charge more for your work and pay income tax, or accept that you cannot charge or deduct anything.
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Right. The simplest thing to do would be to sell it the $10 piece of steel for $13.75, to cover the taxes.

But I'm still stuck on the idea that I can buy an item and sell it for what I paid, and not pay tax on that sale. So I could resell the bare steel for $10 and pay no tax. But if I sharpen the edge, now I have to pay tax.
 
matto6 said:
Thanks Stacy.

My concern is that once this happens (they tell you to stop filing the Schedule C) that makes you a hobbyist, and it also means you now owe tax on everything you've brought in for the last 5 years. No?
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No, if you run it as a business filing a schedule C, and then shut it down because it was not profitable, those years were covered in tax returns.

I had a friend in the music business. He would start an LLC and run it four or five years with only one year making a small profit. Sometimes he would have to fudge the books by NOT deducting some legitimate expenses just to make it show a small profit of a couple hundred dollars. After those five years with only one profitable year, he would close the LLC. The next year he would start a new LLC and go for another four or five years This is completely legal.
The advantage to him was that his travel, lodging, meals, instruments, maintenance, studio percentage of his home, music subscription site fees, EVERYTHING music related was a legitimate deduction as long as he was performing or trying to sell his CDs and music. He would drop by every record shop and radio station when on a trip to give away a copy of his latest CD with his card.
 
matto6 said:
Right. The simplest thing to do would be to sell it the $10 piece of steel for $13.75, to cover the taxes.

But I'm still stuck on the idea that I can buy an item and sell it for what I paid, and not pay tax on that sale. So I could resell the bare steel for $10 and pay no tax. But if I sharpen the edge, now I have to pay tax.
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If that is true, sell it before you sharpen it. It never leaves your possession and the only exchange is in raw materials at the cost paid.
 
You could just not tell the IRS you sold the knife to a friend.

Until you get to be a known seller doing shows, you are pretty much completely under the radar.
I know someone will say, "But you posted about it on Bladeforums".
Well, I bet the IRS with all their staff shortages considers reading thousands of posts on BF not a priority.
 
Stacy E. Apelt - Bladesmith said:
No, if you run it as a business filing a schedule C, and then shut it down because it was not profitable, those years were covered in tax returns.

I had a friend in the music business. He would start an LLC and run it four or five years with only one year making a small profit. Sometimes he would have to fudge the books by NOT deducting some legitimate expenses just to make it show a small profit of a couple hundred dollars. After those five years with only one profitable year, he would close the LLC. The next year he would start a new LLC and go for another four or five years This is completely legal.
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Oh that's not so bad then. You can start the LLC, and if the profits don't come later there's no penalty. You basically ran a non-profit for 5 years, then shut it down.

The advantage to him was that his travel, lodging, meals, instruments, maintenance, studio percentage of his home, music subscription site fees, EVERYTHING music related was a legitimate deduction as long as he was performing or trying to sell his CDs and music. He would drop by every record shop and radio station when on a trip to give away a copy of his latest CD with his card.
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So there's no point in deducting more than you bring in though, right?

Or was the story that he had an office job making $50k/year, a business bringing in $1k/year, and he deducted $10k/year, lowering his tax burden on the $50k?
Because that's starting to sound shady.. and like audit material.
 
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