Finding Out If Casual Income Subject to Income Tax

I've recently received a question about arts and crafts hobby activities - specifically questioning when income from casual arts and crafts business activities has to be included in taxable income. It's just the nature of the beast that some arts and crafts activities don't rise to the level of being a business. Specifically I'm talking about the casual artist or crafter who creates hand-crafted items more for the love of doing it rather than to bring in a sustainable or even part-time income.

For example, you may love making jewelry and end up selling or giving away some of your excess creations to friends. Instances like that or even if you occasionally sell jewelry on a site such as Etsy may not rise to the level of being a business, rather for tax purposes you may be classified as hobbyist who occasionally sells items.

Hobby Loss Rules

Understanding when you are participating in a hobby that occasionally brings in money versus a business is very important. And remember, bringing in some extra cash now and then is quite difference from having income - hobbyist usually end up selling their items at a loss after deducting all expenses relating to making the item. You don't show the hobby income and related expenses on your tax return the same way as you would if you are a sole proprietor arts and crafts business owner. Check out my article on hobby losses for more information.

Recording Arts and Crafts Casual Income

Now that I've laid a little groundwork on the topic - here's the question:

Question: If I start selling arts and crafts, do I have to register a business first? Then, when do I have to start paying taxes? For example, if I sell household items in a yard sale, I don't need to have a business. I am not making money there, just change for getting rid of things. But if I make more than say $200, or $X (Whatever value), I should pay taxes on it. I guess my question is what is the "X" value?

Answer:

First let's address the issue of registering a business. This is not a tax issue, it is a city/county licensing issue governed by the location at which you operate your arts and crafts business. If you plan to incorporate your business, you also have to get in touch with your Secretary of State to file the appropriate paperwork.

Understanding Why Garage Sales Normally Aren't Income

The reader hits the nail on the head when they state that garage sales are usually held to get rid of excess stuff around the house for some spare change. The reason why you normally don't have to worry about paying taxes on garage sale proceeds is because the proceeds don't = income. You only have income if you sell your garage sale stuff for more than you paid for it. This rarely happens. But if you sell for example a coin for more than you paid for it - you would owe capital gains tax on the sale.

Explaining the Income "X" Factor

I can't think of a single situation where you will owe income tax on gross sales (you may however owe sales tax). What you will owe income tax on is the amount left over after you pay for all expenses you incur in the production of that gross sale.

As an arts and crafts business owner, when you have a profit from selling an item, you have a taxable event. For example, you sell a ceramic pot for $50 and it cost you $25 to make it. Your taxable income from the sale is $25 ($50 - $25). In other words, there is no minimum you have to have in profit to have to add it to your adjusted gross income on your tax return. If you are self-employed you do not have to pay self-employment tax (the self employed version of FICA) unless your tax for the year is over $399.99.

So the quick and dirty answer to this question: there is no "X" factor for having to include income on your Form 1040. The "X" factor for self-employment tax is $400 in tax - not income.