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

Start an LLC. Sell your knives for a very small profit instead of giving them away. Then you just deduct all your costs and pay few dollars in taxes. It's easier and cheaper to make a small amount of money so you can run a legitimate business. If you make 12 knives next year, mark them up 10 bucks over cost and put 100 bucks in your pocket and send the irs 20 bucks. I'm sure anyone getting a custom knife would be okay with you making 10 bucks on it.
 
Rick Marchand said:
Aussiestan
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I don't believe they have a free hobby market. There is a catch, for sure. All taxian countries are companies and as such all income is taxable. How they proceed by their own rules is another story. Money from a hobby is fully taxable everywhere.
Edit: Found it. Aussies will have to keep their hobby income low. If it generates money that can influence their lifestyle (being better) than their business than it's a tax fraud. For true hobbyists it's better to be Aussie than US or EU.
 
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---> Wait until you have to start paying tax on equipment you already own outright. <---

Own a house, you pay tax on that

Own a car, boat, airplane or trailer, you pay tax on that

Buy a grill for your deck, you pay sales tax, but once you buy it they don't come after you for more every year. That would be crazy, right?

Buy a CNC machining center for your business, and damn if they don't feel entitled to come after you every year for a just little bit more $$$. Every year. Property tax.

They want you to pay tax on the toilet paper and printer ink you buy in one year but don't use until the next. I spend over 12K a year on bookkeepers and accountants just trying to keep up with all this BS.

The flip side to this is, being a real corporation with employees during covid, recessions, election year, whatever they just print money and give it to you. So I guess it's a wash? SMH...
 
You are looking for an easy answer and in tax and business law there are no simple answers. In my home state even hobbies are considered fair game for B&O taxes regardless of making a profit or not. If there's a monetary exchange the state or local governments want their tax share.
You want real answers consultant a tax layer or accountant.
 
True Timos! With electronic money coming they won't need to guess if you're selling something. Their AI computers will see you receiving funds and automatically call it income. Reason for receiving funds won't matter.
 
This has been interesting to read through … but if it is true that the OP “just wants to understand the tax code and comply with the IRS”, then the answer is quite clear: if you sell something for any amount (even like $1), regardless of expenses, you are running a business, and can deduct expenses. BUT, there is some line (a little grey) where the IRS will say “wait … you sold $1 in product and deducted $1000 in expenses … that is a hobby … you cant do that …”. If however, you deducted your material expenses and sold the knife for material expenses + $1, it would look like a profit and the irs would basically say “ok”. Forget about this if you tried to include your equipment costs …. Your deductions would be too high…

If you start an LLC, the llc financial books need to be TOTALLY separate from your personal finances. This means if you bought a grinder for the llc (and deducted it), you CAN NOT use that grinder for personal purposes (doing so would be a rather nasty case of tax fraud). You can, however, buy a grinder for personal use (and NOT deduct it), and “lend” it to the llc for occasional use. Also, there is nothing in the tax code that says you MUST deduct all expenses … only that if you do take a deduction, you need to retain records to substantiate the claim.

Thats the letter of the regs (at least a portion of them) … if you sell something … anything … you are running a business. BUT, there is an unwritten “is this reasonable” cloud around this (which stacy alludes to when he says its not worth the irs time to pursue something). Think about it … if you sell a household item on nextdoor or craigslist, technically you are running a business … but basically nobody declares that income, and the irs does not pursue them (and it is very arguable they have no clue they have that income). Without giving specific advice, i would instead venture the observation that if you make a few knives a year for family and friends, and ask them to compensate you for materials, then your “risk” with the irs is extremely small … tucked right in there with all the folks selling stuff on craigslist.

I second other folks saying that if you do want to declare the income, get an accountant to do the taxes … they will be able to guide you.

You could go the llc route, deducting just material expenses, and reporting income of, say, material expenses plus $1, and you would be just fine … BUT you have to keep explicit books on the cash flow, and keep it totally separate from personal expenses … up to you whether you want to go to that pain (again, having an accountant complete the taxes is a good idea). The self employment taxes would be pretty much non existent if your “profit” is that small (btw … if you are an employee of a company, something that is invisible to you is that when the company pays you, they ALSO pay payroll taxes to the irs. The “self employment taxes” are the equivalent of the payroll taxes … so from the perspective of the profit-generating entity, there is no difference, you just see them personally because you are the profit-generating entity.

(I have been running an LLC for about the last eight years, reporting both as a sole-proprietership, and as as S-corporation (paying payroll and filing payroll taxes). The last few years i have reported zero income, but some significant expenses (ive had to keep liability insurance in place and also pay for admin of a 401K account), and the IRS has had no complaints at all (of course, because of the separation between personal and corp cash flows, the “loss” from the llc has no effect at all on my personal taxes). Im finally shutting down that llc this december)

Hopefully that helps the OP somewhat…
 
Nathan … you dont pay property taxes on the CNC equipment itself … just on the building/property taxes … right?

Also … property taxes are state/local taxes … not federal, i believe…
 
kreole said:
If getting advice, I'd suggest getting advice from an accountant, not a tax professional (tp working under an accountant is probably okay though). CPA is a legitimate title requiring certain knowledge. Anyone who can get a ptin is a "tax professional".
(Source: I was a "tax professionl" at an accounting firm and H&R Block to pay for grad school. It takes almost nothing to get started. )
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Actually, Enrolled Agent is also a legitimate title which is what I have used for numerous years as a sole proprietor. CPAs can have numerous other roles and might not specialize in taxes. Certainly qualified, but not the only recognized title associated with tax preparation.
 
matto6 said:
So you chimed in just to tell me me I'm getting everything wrong, but that you're not willing any help in any way to point me in the right direction.

Thank you kind sir, for your positive energy and constructive contributions to this thread.
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I think you misunderstood my point. I chimed in to say that would be irresponsible for me to give anything regarding advice on something I am not qualified to give.
 
Cushing H. said:
Nathan … you dont pay property taxes on the CNC equipment itself … just on the building/property taxes … right?

Also … property taxes are state/local taxes … not federal, i believe…
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Most states have taxes on "business personal property" covering things like fixed assets and inventory. I just went through the bills today from every county the company I work for does business in. So yes, he does pay tax on the equipment. And you're also correct, property taxes are typically at the county level, at least in Texas.

The simplest way to handle a profitable hobby is to treat it like a business. Keep well organized separate records, demonstrate an intent to make profit, and make profit in at least 1 of 3 years. You can deduct your business expenses against your business income on your Schedule C, and that's fine, just don't always show a loss. As a CPA, I would advise you not to try to game this last bit too much. You don't have to incorporate as an LLC (that's state level, not federal) though you should for the liability separation, and it gives weight to your claims that it's a business rather than a hobby.

Where you get in trouble is if you get audited and the IRS says that your business is really a hobby because you failed to meet the criteria above. In that case, you'll have to pay back taxes on all of your hobby income that you previously offset with claimed expenses. There's plenty of good info out there that doesn't require a CPA to interpret. That said, any good CPA should be asking you detailed questions about your business/hobby, and can advise you about how to handle each situation. I AM a CPA, and I'd want to be very clear in both my understanding of my clients' operations and my own understanding of the tax code.

Practically speaking, however, Stacy is right--the IRS won't notice you or care, and it's not worth their time to find out. This was especially true the last decade or so when the IRS has been grossly understaffed, but that may change now that they're beefing up their workforce. That said, hobbies and hobby losses are one of the biggest potential red flags that could draw an audit, and one of the first things an auditor will look at. If they catch you on the wrong side of that issue, they'll look a lot harder at everything else. The best defense is 1) following the rules and 2) keeping well organized records. If you hand an auditor clean, well organized business records that tie to your tax forms, they'll likely give you a hug and take a cursory look. They may even buy you lunch. If you give them a disorganized shoebox full of receipts, they'll be annoyed from the start that they're forced to dig through it all. And they'll assume that you run everything as well as your keep your records, and that you're probably hiding something. Your documentation is your shield.
 
Travis Fry said:
Most states have taxes on "business personal property" covering things like fixed assets and inventory. I just went through the bills today from every county the company I work for does business in. So yes, he does pay tax on the equipment. And you're also correct, property taxes are typically at the county level, at least in Texas.
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Huh ... .I never knew that .... though I have not handled depreciating capital equipment associated with my LLC. thanks for the info.
 
Travis Fry said:
Most states have taxes on "business personal property" covering things like fixed assets and inventory. I just went through the bills today from every county the company I work for does business in. So yes, he does pay tax on the equipment. And you're also correct, property taxes are typically at the county level, at least in Texas.

The simplest way to handle a profitable hobby is to treat it like a business. Keep well organized separate records, demonstrate an intent to make profit, and make profit in at least 1 of 3 years. You can deduct your business expenses against your business income on your Schedule C, and that's fine, just don't always show a loss. As a CPA, I would advise you not to try to game this last bit too much. You don't have to incorporate as an LLC (that's state level, not federal) though you should for the liability separation, and it gives weight to your claims that it's a business rather than a hobby.

Where you get in trouble is if you get audited and the IRS says that your business is really a hobby because you failed to meet the criteria above. In that case, you'll have to pay back taxes on all of your hobby income that you previously offset with claimed expenses. There's plenty of good info out there that doesn't require a CPA to interpret. That said, any good CPA should be asking you detailed questions about your business/hobby, and can advise you about how to handle each situation. I AM a CPA, and I'd want to be very clear in both my understanding of my clients' operations and my own understanding of the tax code.

Practically speaking, however, Stacy is right--the IRS won't notice you or care, and it's not worth their time to find out. This was especially true the last decade or so when the IRS has been grossly understaffed, but that may change now that they're beefing up their workforce. That said, hobbies and hobby losses are one of the biggest potential red flags that could draw an audit, and one of the first things an auditor will look at. If they catch you on the wrong side of that issue, they'll look a lot harder at everything else. The best defense is 1) following the rules and 2) keeping well organized records. If you hand an auditor clean, well organized business records that tie to your tax forms, they'll likely give you a hug and take a cursory look. They may even buy you lunch. If you give them a disorganized shoebox full of receipts, they'll be annoyed from the start that they're forced to dig through it all. And they'll assume that you run everything as well as your keep your records, and that you're probably hiding something. Your documentation is your shield.
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Very good responses from everyone.

I keep getting hung up on my readings of various articles.
Something as simple as what's my income??? I'm sorry.

Is income only profit? or everything getting paid.

Hypothetically
In our hobby we occasionally make knives.
We make the knife.
it cost $100 to make (cost of steel, heat treat, handle material, shipping costs, hardware, sheath costs, epoxy, belts)
we sell it for $200.


Is our income we pay taxes on the $100 of profit, or of the total received from our buddy ($200?)


I really wish I now had taken some more business classes.
 
Crag the Brewer said:
Very good responses from everyone.

I keep getting hung up on my readings of various articles.
Something as simple as what's my income??? I'm sorry.

Is income only profit? or everything getting paid.

Hypothetically
In our hobby we occasionally make knives.
We make the knife.
it cost $100 to make (cost of steel, heat treat, handle material, shipping costs, hardware, sheath costs, epoxy, belts)
we sell it for $200.


Is our income we pay taxes on the $100 of profit, or of the total received from our buddy ($200?)


I really wish I now had taken some more business classes.
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IF you manage it as a business and keep good records (as indicated above), and also report the expenses as deductions, then you pay taxes on the PROFIT (in your example 200 income minus 100 expenses, for a profit of $100. but again, in any situation, you need to keep explicit records and accounting of the business expenses and income versus your personal cash flow.
 
Crag the Brewer said:
I keep getting hung up on my readings of various articles.
Something as simple as what's my income??? I'm sorry.

Is income only profit? or everything getting paid.

Hypothetically
In our hobby we occasionally make knives.
We make the knife.
it cost $100 to make (cost of steel, heat treat, handle material, shipping costs, hardware, sheath costs, epoxy, belts)
we sell it for $200.


Is our income we pay taxes on the $100 of profit, or of the total received from our buddy ($200?)


I really wish I now had taken some more business classes.
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This may help. Slightly oversimplified but still accurate:

Revenue= All the money you took in from sales or product
Cost of Goods Sold (COGS)= the money you spent (time and materials) to make the thing. COGS are expenses too, just a more precise label for the expenses directly related to production.
Gross Income= The difference between the above

Operational/Administrative Expenses= All the other things it takes money for to run a business. Utilities, fuel, travel, show fees, advertising, accounting costs, whatever else. Often referred to as Overhead since it can't be allocated to a specific produced item. Includes depreciation, which is just the recognition of the cost of machinery over the life of the asset rather than at the time of purchase.
Other Income/Expense= Money you took in from sales or activities not directly related to your business. Gains or losses on sales of assets (like if you sold a grinder because you got a new one, that money would be other income rather than revenue because you aren't in the business of selling grinders), interest income, etc.

Net Income= Gross Income- Expenses +- Other Income/Expense

That about covers a basic profit and loss statement, which is a good start for your Schedule C.
 
Nathan is correct in alot of states including my home state of WV. It's called inventory and property tax. We just had a state wide vote on this in the primary as a constitutional amendment. It failed miserably because folks here are wary of more government control. OF course it was tied to other benefits like personal property including car taxes. In WV you pay a car tax when you buy the car and a property tax on it every year afterward as long as you own it. It's called your 13th annual car payment here. IF a new business locates here they often get a pass in leau of a one time payment in leau of taxes yearly. It sucks if your a business that has been in business for eons and get taxed on ALL INVENTORY including machinery.

I run a separate small business (not knife related) and claim all my income and expenses. Run it through my tax accountant. TRUST me the going rate is 35% of taxes with held.

PLEASE keep in mind the present administration is proposing to hiring 87 thousand new IRS agents. They are not going to be only looking at billionaires. They have admitted they will start the training of new agents on ALL individuals and small business's before they release them on all those horrible billionaires. The billionaires who can afford the best tax lawyers and tax accountants!
 
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Crag the Brewer said:
Very good responses from everyone.

I keep getting hung up on my readings of various articles.
Something as simple as what's my income??? I'm sorry.

Is income only profit? or everything getting paid.

Hypothetically
In our hobby we occasionally make knives.
We make the knife.
it cost $100 to make (cost of steel, heat treat, handle material, shipping costs, hardware, sheath costs, epoxy, belts)
we sell it for $200.


Is our income we pay taxes on the $100 of profit, or of the total received from our buddy ($200?)


I really wish I now had taken some more business classes.
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They are both income, the 200 is your gross income, the 100 is your net income. You pay taxes on your net income, but if you've depreciated something like a truck, the banks can add that back to your "net" even though you haven't paid taxes on that money. So there is another grey area there that gives buying power but didn't cost you in taxes.

This is the building point of a business often times. You basically made money, but chose to invest that back into your business, so it's money you could have made, but didn't...by choice, so banks and the irs look at it different than just not making any money. In a way it's kicking the can down the road, but makes sense on things that lose value over time.

Example
Contractor brings in 300k total.
200k is cost
100k is profit.
Buys 80k truck...pays taxes on remaining 20k. Saves 20k in taxes by buying 80k truck......some view this as buying an 80k truck for 60k, it's not quite that simple, but not too far off.
Bank still sees 100k for loans, keeping debt to income ratios high so you still have buying power. Run the truck for 5 years and sell for 40k.

Pay taxes on the 40k instead of 80k.

It's all designed to keep your money moving. They don't want everyone to have 100k sitting in the bank not doing anything....so the tax code is designed to encourage people to move their money.

If they catch giving knives away for free, you might have to bight the bullet and stroke that 100 dollar check...but that's unlikely if you have recepts because you've made zero dollars.

Profits are profits in all situations including bartering and gambling, so there really isn't anyone that doesn't cheat in some way even if unknowingly according to the letter of the law.

The irs is business that intends to profit for the government.....they aren't trying to chase down 20 dollar checks, their cost to recover 20 dollars is over 20 dollars resulting in a net loss for them. They aren't coming for your 20 bucks.

The scariest part about this whole thread is that a guy looking to give some gifts away is afraid of our government for doing so. The mistakes we've made can't be fixed with taxes or money.
 
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