Woodturning and taxes

[Lee DeRaud]

For you guys that make enough money at this to file a Schedule C:

How do you handle "consumables" like wood, sandpaper, glue, and finishing supplies? Do you just expense whatever you buy each year or do you have to treat it as inventory?

(My apologies for posting this in multiple forums, but I suspect I'm going to get different answers depending on the type of work being done.)

[Phil St.Germain]

Lee,

Not that I make alot of money, but I do file a Schedule C. The federal guidelines give a pretty good explanation of what constitutes inventory. For the levels that I do, I just expense everything. It is much simpler. If you are doing very high volumes, then you will have to use the inventory method.


Phil

[Dean Thomas]

Consumables are not inventory. Yes, expense anything that should not last a year under normal conditions. If you buy 1000 sheets of sandpaper, that's an expense. If you buy 1000 pen kits and only plan to use 50 per month, you can play inventory games then.

Make a rule and write it down about your tools. Some tools are depreciable. Lathes and other standing tools would be such critters. Your chisels may or may not be, depending on your rule and depending on your use. If you go through 3 3/8" spindle gouges each year, you'd expense those off in that year. If you buy one new 2" scraper every 5 years at $150 each, and your "rule" says anything over $100, you'd depreciate that over 5 years.

Grossly over simplified, but it can work that way.

Inventory is mostly for goods that are purchased for resale, not so much for goods purchased as part of a manufacturing process.

An hour with a good tax preparer will cost you less now than it will in January. You might even get away for a few beers and some chips and a nice bowl to put them in. Doesn't hurt to ask, yes?? That kind of advice can keep you out of trouble and keep you from pulling your hair out trying to reinvent something that already works.

[Lee DeRaud]

Consumables are not inventory. Yes, expense anything that should not last a year under normal conditions. If you buy 1000 sheets of sandpaper, that's an expense. If you buy 1000 pen kits and only plan to use 50 per month, you can play inventory games then.I guess the biggest issue I'm having in my head is with wood. (No smart remarks please.) It's not like it has a shelf-life, but it's not like you can pull out the receipt for any given purchase at the lumberyard and the corresponding sales invoice(s) that resulted from it either.

The obvious "path of least resistance" is to expense all wood purchased in any given tax year and ignore that big (and growing) pile of leftover wood in the garage. Clearly (in the long run), it all balances out, as any given income-producing piece will consume some of that wood at some point...at least in theory.

(That said, I shudder to think what some suit at the IRS would think of the amount of purchased wood that does not end up in an income-producing piece but instead ends up as hamster bedding.)

[Lee DeRaud]

The obvious "path of least resistance" is to expense all wood purchased in any given tax year and ignore that big (and growing) pile of leftover wood in the garage.On further review, the real "path of least resistance" is to simply add up the price of any sold pieces and say, "Yup, pure profit, didn't cost anything to make those puppies." And then just turn around and bend over so the nice man from the IRS can easily access my wallet and anything else that strikes his fancy.

Am I the only one who thinks that's a bad idea?

[Frank Kobilsek]

Lee,
Last year I gave my guy:

Material Purchases - wood, pen Kits, etc in one category

Supplies - Sandpaper, finishes, etc. in a category

Tools -

Business exp - Mileage, dues, subscriptions, class fees, symposium registrations

Revenue - Sales

For this year he wants inventory. But only inventory that I spent money on. Blocks cut from logs found at the city dump have no value until they are sold. Also WIP or work in progress is only as valuable as the chunk of wood that it was made from unitl it sells, ie. rough outs and finished goods.

He tells me that every penny I take in should be reported as income but if my expenses don't add up to 5% or more of my total income (real job) that he will discourage the Schedule C effort. So now I use that to convince my lovely wife that I need to buy tools so I can write them off. My guy also says that every few years I need actually make a profit to keep this OK with the feds.

My two cents worth.

Frank

[Marvin Hasenak]

For the majority of woodworkers this is really just a hobby. you are required to report your income and are allowed expenses up to the amount of the your income. To claim it as a business or schedule C profit or loss can become a very grey area. You need to show a profit 2 out of 5 years to show that it is a business. This is where it becomes tricky, some of people will fake a small profit for those 2 out 5 years but report major losses in the 3 loss years. As an example 2 years of a profit of $500 and then 3 years of losses $5000. In this case your tax return might be scrutinized a little more in detail, and if the determination is made that you have a hobby not a business, the result will be you pay taxes on the losses that you claimed. The taxes plus interest from the due date of the returns with losses can add up to a pretty large sum.

If you think you will never really make a profit, and it is really a hobby, my pennies worth of thoughts is report it as a hobby and take the safe road. I worked in the accounting field too long and have seen a lot of people hurt with this issue, not the IRS's fault but their accountants fault, and you have to pay the tax. I recommend getting qualified tax advice, either by going to a CPA or an Enrolled Agent, both are licensed to practice before the IRS and should keep you out of a lot of trouble.

[Lee DeRaud]

For the majority of woodworkers this is really just a hobby. you are required to report your income and are allowed expenses up to the amount of the your income. To claim it as a business or schedule C profit or loss can become a very grey area. You need to show a profit 2 out of 5 years to show that it is a business.
(snip)
If you think you will never really make a profit, and it is really a hobby, my pennies worth of thoughts is report it as a hobby and take the safe road. I worked in the accounting field too long and have seen a lot of people hurt with this issue, not the IRS's fault but their accountants fault, and you have to pay the tax. I recommend getting qualified tax advice, either by going to a CPA or an Enrolled Agent, both are licensed to practice before the IRS and should keep you out of a lot of trouble.I don't have a problem with that approach, since all I'm ever trying to do by selling stuff is to clear room on the shelves and cover some of my wood costs. (You'll notice I have not used the word "profit" anywhere previously. :p)

But while I see where to report the income (1040 line 21), I don't see any way to claim the offsetting expenses without doing Schedule C. Which form/line does that?

[Marvin Hasenak]

Unfortunately that goes on schedule A, if you do not itemize deductions you are out of luck.

Marvin

[Lee DeRaud]

Unfortunately that goes on schedule A, if you do not itemize deductions you are out of luck.

Marvin
Kinda what I thought (I've been rooting around on the IRS web site for the last 30 minutes)

Schedule A isn't a problem, but it looks like (as near as I can tell) it goes under "Miscellaneous Deductions"...
which is subject to the 2% AGI exclusion. That's a lot of pens/bowls/whatever.

[Paul Heely]

Continuing here from my reply in the off topic forum

Originally Posted by Paul Heely http://www.sawmillcreek.org/images/buttons/viewpost.gif (http://www.sawmillcreek.org/showthread.php?p=705236#post705236)
For consumables I will be expensing them for the year. Inventory that is sold goes toward cost of goods sold this year. The distinction I was told for consumables vs inventory was that inventory can be attributed to a specific sale, i.e. an individual pen kit or blank, but consumables cannot, i.e. finish and paper towels.

Reply by Lee:
That's kind of where I'm hung up. It's ok to talk about things like pen kits and bowl blanks being attributed to a specific sale, but that only works for "discrete" material purchases. In the same situation, a pen turner who buys a long piece of 12/4 stock and cuts his own blanks probably will have a bunch of raw stock left over at the end of the year...how is that handled?


I count raw stock that I purchase as inventory. If I convert wood from one item to another I do an inventory adjustment. For example I just bought some 2x8x8 bowl blanks with the intention of cutting them up into 2x4x4 blanks for confetti lamps. If the original blank cost $4 and I cut it into 4 confetti blanks I do an inventory adjustment of -1 bowl blank @ $4 and +4 confetti blanks @ $1. This way my inventory stays straight and my cost of goods sold should be correct at years end.

[Christopher K. Hartley]

Good info, thanks for the question Lee!:)

[Marvin Hasenak]

There are some regulations that only a tax professional will be able to keep up with. Myself I have been out of tax work for several years, I don't even do my own anymore, I leave that to a professional. As I was looking for info on this subject I did come across something about if it is a hobby you can deduct your cost of good sold from your gross sales and only report the net as income on the front page. But the remaining expenses are schedule A miscellaneous deduction. But I never found a regulation or tax code reference, so that is it even really valid info?

My advice is still get professional tax advice, but even then you are the responsible party, not the professional.

[Lee DeRaud]

As I was looking for info on this subject I did come across something about if it is a hobby you can deduct your cost of good sold from your gross sales and only report the net as income on the front page. But the remaining expenses are schedule A miscellaneous deduction. But I never found a regulation or tax code reference, so that is it even really valid info?I'll take a look for something like that, but it sounds unlikely.
(Not to mention a PITA to document...that's what started this thread.)

[Marvin Hasenak]

Hit this with Google "§183 and Reg §1.183-1 - 1.183-4" Then look for the 1.183 in the list of the regs and read it.:confused: Then take 2 aspirin and call a professional in the morning.:D If you have nightmares or any other problems it was not the aspirin.:D

Marvin

[Lee DeRaud]

Hit this with Google "§183 and Reg §1.183-1 - 1.183-4" Then look for the 1.183 in the list of the regs and read it.:confused: Oy. :eek:

Got a couple layers in and realized this is what people in my former life (the aerospace business) call a "scavenger hunt": each step simply leads to another puzzle one step further removed from the original question.

Too bad...would have been nice to be able to deduct at least a little of the raw material for any sold items, but the numbers just don't work out. And I agree, at this level the Schedule C kabuki dance just doesn't make sense.

[Dean Thomas]

The deal here is that if you're doing this as a business, you need to treat it as a business. Sole proprietorships have a tendency to wear a body out. Been there, done that. Save receipts and make sure they are dated. Sort 'em out according to a few categories (like the ones found on the Schedule C) and keep 'em in separate piles for your own sanity. Count every nickel that goes out and every one that comes in.

If you report your loss and write "hobby" across the top, I don't think they credit the loss against you where they would if it were a business. But if you make a profit, they want to tax you for it; self-employment tax (SE) is over and above "regular" taxation and includes some $$ for the Social Security and Medicare columns on Uncle's ledger.

Plus you have to be careful about what you claim and how you claim it. Tax prep and advice fees are deductible. Fees that you pay in order to sell at a show are deductible. Some mileage is deductible, but you have to have a mileage log for ALL THE MILES you put on that vehicle so that you can prove it. Some folks have gotten stung for not having that log and losing the expense (big bucks!) of their mileage. Also, find out what they consider as the commute mileage now. I'm not sure what the rule is now, but for a while, your first trip of the day was considered a commute and was not deductible! A friend made sure that his first trip was to his PO Box (rental of which is also deductible).

And if you grossed less than $440 in 2006, you were not liable for SE tax. You still had to file the Schedule C, but not the Schedule SE.

One super good reference is the IRS Publication 17, considered to be "the bible" for individual taxpayers. It's not an easy read but beats the heck out of trying to ferret one's way through the sections and subsections of the IRCode.

This stuff is not to be entered into lightly. Fear and trepidation is closer. And if you have ANY questions, you can call IRS for a technical opinion. 1-800-829-1040 (800-TAX-1040). They do have small business experts available on the phones who will provide you with opinions in writing so that you can document the reasons for why you did what you did. The "in writing" part is critical.

Also, look at this little site (LINK) (http://www.wwwebtax.com/income/hobby_income.htm). What seems to be pretty good info on your options.

Hope it helps.

[Randy Cohen]

I'm a currently practicing CPA.....almost 40 years experience. If you are reporting as a hobby your COGS is a hobby expense or you would include everything in COGS....yes?
If I were asked to prepare taxes for a crafts person (including turners, furniture makers, painters, etc.)I would encourage the use of Sched C to report income and expenses. There is also, besides the profit rule, an hours spent rule. Without looking it up (this is one of those places that CPAs make some extra money...research)I couldn't off hand say what that number is. But if you are working at your craft for that amount of hours then whether you have a profit or loss makes no difference. So my first question to a client who shows a loss is to ask how much time is spent on their 'hobby'.
I would not hesitate to take a Sched C loss on a tax return that I sign.
Now as far as inventory goes, its a general rule to try to match income with their associated expenses. But inventory is one of the most 'flexible' numbers on a tax return. It is common for non-SEC clients to use that number to gain tax advantage. But especially in your first reporting year it will reduce your loss or increase your profit.
Going forward, you start the next tax year with expenses from the prior year.
So what to include in inventory? i would want my client to include anything purchased for use in a specific job that has not been completed at year end.....or if it has been completed than title has not passed to the buyer. If your have a can of finishing material and its open and partially used I would consider it consumed. If you have leftover wood from a completed job I would consider it consumed. But if you bought some materials in expectation of producing 100 pieces and you have completed and sold 25 pieces than I would expect that your inventory is the cost of 75% of those materials.