hobby income, use gross revenue or gross income?

[Brew1]

an NATP presenter at an IRS forum on Schedule C issues said you could
subtract cost of goods sold from the income reported on Line 21. IRS
says report all income but does not distinguish between revenue and
income, as you would on a Schedule C. Any comments?

 

[John Fisher]

an NATP presenter at an IRS forum on Schedule C issues said you could
subtract cost of goods sold from the income reported on Line 21.  IRS
says report all income but does not distinguish between revenue and
income, as you would on a Schedule C. Any comments?

Gross income from hobby is reported on line 21 (other income).
Deductions are taken on Schedule A.but (generally) only to the extent
of the gross income from that hobby. The deduction is also reduced by
2% of ones adjusted gross income.

 

[Alan]

an NATP presenter at an IRS forum on Schedule C issues said you could
subtract cost of goods sold from the income reported on Line 21. IRS
says report all income but does not distinguish between revenue and
income, as you would on a Schedule C. Any comments?

The NATP presenter is correct. Your gross income (GI) from a
not-for-profit activity is computed in the same manner you would compute
it for a profit activity. You take your gross receipts and subtract your
cost of goods sold to arrive at GI for Line 21. If you had returns and
allowances you could also subtract that to compute GI.

 

[D. Stussy]

an NATP presenter at an IRS forum on Schedule C issues said you could
subtract cost of goods sold from the income reported on Line 21. IRS
says report all income but does not distinguish between revenue and
income, as you would on a Schedule C. Any comments?

Correct. The cost of goods is an element in determing gross income.

The INDIRECT expenses (on a Schedule C, lines 8+) are NOT part of gross
income. They are an adjustment to gross income to arrive at AGI.
- Authority: IRC Section 62(a)(1).

Therefore, if the activity fails to qualify as a business (e.g. "hobby"),
1040 line 21 is gross receipts less cost of goods, and the indirect
expenses belong on Schedule A.

This is why drug dealers (whose expenses are denied under IRC 162(f)) still
get their cost of goods for their tax computation.


Gross income = Gross receipts - cost of goods - returns/allowances.
Gross income is always AFTER INVENTORY COSTS.

 

[D.F. Manno]

This is why drug dealers (whose expenses are denied under IRC 162(f)) still
get their cost of goods for their tax computation.

IRC 162 (f) reads:

(f) Fines and Penalties -
No deduction shall be allowed under subsection (a) for any fine or
similar penalty paid to a government for the violation of any law.

I don't see how that denies other deductions (e.g., costs of supplies
such as glassine bags).

 

[Alan]

IRC 162 (f) reads:


I don't see how that denies other deductions (e.g., costs of supplies
such as glassine bags).

Wrong code section. It's Sec. 280E:

§ 280E. Expenditures in connection with the illegal sale of drugs

No deduction or credit shall be allowed for any amount paid or incurred
during the taxable year in carrying on any trade or business if such
trade or business (or the activities which comprise such trade or
business) consists of trafficking in controlled substances (within the
meaning of schedule I and II of the Controlled Substances Act) which is
prohibited by Federal law or the law of any State in which such trade or
business is conducted.

 

[Stuart A. Bronstein]

õ 280E. Expenditures in connection with the illegal sale of
drugs

No deduction or credit shall be allowed for any amount paid or
incurred during the taxable year in carrying on any trade or
business if such trade or business (or the activities which
comprise such trade or business) consists of trafficking in
controlled substances (within the meaning of schedule I and II
of the Controlled Substances Act) which is prohibited by Federal
law or the law of any State in which such trade or business is
conducted.

Does that mean medical marijuana dispenseries will have to be
nonprofits to avoid tax problems?

 

[Bill Brown]

§ 280E. Expenditures in connection with the illegal sale of drugs

No deduction or credit shall be allowed for any amount paid or incurred
during the taxable year in carrying on any trade or business if such
trade or business (or the activities which comprise such trade or
business) consists of trafficking in controlled substances (within the
meaning of schedule I and II of the Controlled Substances Act) which is
prohibited by Federal law or the law of any State in which such trade or
business is conducted.

Just curious. How does the quoted section allow deduction of cost of
goods sold?

 

[D. Stussy]

IRC 162 (f) reads:
law.

I don't see how that denies other deductions (e.g., costs of supplies
such as glassine bags).

I may have miscited the subsection. However, it might be case law under
this or subsection (c). Either way, violations of law are not considered
"ordinary and necessary" as stated in subsection (a).

 

[Alan]

Does that mean medical marijuana dispenseries will have to be
nonprofits to avoid tax problems?

I'm guessing here (we need a lawyer). Marijuana is still classified as a
Schedule I drug. However, one may conclude that Schedule I marijuana is
non-prescribed marijuana as Schedule I drugs and substances require:
There is no currently accepted medical use in treatment in the U.S. and
there is a lack of accepted safety for use of the substance under
medical supervision. It seems to me that prescribed medical marijuana
would be excepted from Schedule I.

 

[Alan]

Just curious. How does the quoted section allow deduction of cost of
goods sold?

Because Sec. 161 says:

§ 161. Allowance of deductions
In computing taxable income under section 63, there shall be allowed as
deductions the items specified in this part, subject to the exceptions
provided in part IX (sec. 261 and following, relating to items not
deductible).

Sec. 63 says:

§ 63. Taxable income defined
(a) In general
Except as provided in subsection (b), for purposes of this subtitle, the
term “taxable income” means gross income minus the deductions allowed by
this chapter (other than the standard deduction).

Therefore I conclude you start with gross income and take your business
deductions unless Part IX (this includes Sec. 280E) says otherwise.

 

[Alan]

I'm guessing here (we need a lawyer). Marijuana is still classified as a
Schedule I drug. However, one may conclude that Schedule I marijuana is
non-prescribed marijuana as Schedule I drugs and substances require:
There is no currently accepted medical use in treatment in the U.S. and
there is a lack of accepted safety for use of the substance under
medical supervision. It seems to me that prescribed medical marijuana
would be excepted from Schedule I.

I did a little research on CA law, as that state has the largest number
of dispensaries, CO, my closest neighbor that has legalized it and my
home state of NM. CA law is quite clear that dispensaries must be
non-profit organizations. It also appears that you can't sell for cash.
(That's not to say that every dispensary is following the law.) I could
not find anything in CO law that requires the licensed establishment to
be nonprofit nor could I find anything in NM law that requires the
licensed producer to be nonprofit.

I'm not sure what all this means for tax purposes.

According to medicalmarijuana.procon.org there are now 14 states + D.C.
that have legalized MM and two states that have laws that look favorably
at MM (AZ allows a Dr. to prescribe and MD allows a defendant to use MM
as a defense.

If anyone wants to look up the laws for each state, here is the link:
http://medicalmarijuana.procon.org/view.resource.php?resourceID=000881

 

[D. Stussy]

Just curious. How does the quoted section allow deduction of cost of
goods sold?

I forgot about that section.

However, let me answer your question with this one.
280E disallows expenses otherwise claimable under section 162.
Where in 162 does it mention inventory? (It doesn't).
Therefore, inventory costs are NOT part of IRC 62(a)(1), and are therefore
part of gross income, not an adjustment to arrive at AGI.

Inventories, for computation of income, come in via the "Accounting
Methods" part (Subtitle A, Part II, Subpart D = Sections 471-474).

Note also that the denial is for trafficking, not for manufacture. ;-)

 

[Mark Bole]

Correct. The cost of goods is an element in determing gross income.

The INDIRECT expenses (on a Schedule C, lines 8+) are NOT part of gross
income. They are an adjustment to gross income to arrive at AGI.
- Authority: IRC Section 62(a)(1).

Therefore, if the activity fails to qualify as a business (e.g. "hobby"),
1040 line 21 is gross receipts less cost of goods, and the indirect
expenses belong on Schedule A.

[...]


What's really annoying, is that if your hobby involves shipping your
inventory to people who pay for that, you must include the shipping
income in gross income on line 21, but you can only deduct the shipping
expenses on Sched A subject to 2%-of-AGI limitation (because it is not
part of COGS)....even if you simply pass along the shipping expenses
with no mark-up. Shipping can easily exceed the sale price of many
items produced as a result of hobby activities.

Gross income = Gross receipts - cost of goods - returns/allowances.
Gross income is always AFTER INVENTORY COSTS.

Agree. Just as gross income from sale of capital assets is not the
gross proceeds, but the gain on the sale (loss on sale equals zero gross
income).

-Mark Bole

 

[Dick Adams]

Just curious. How does the quoted section allow deduction of cost of
goods sold?

Lest we forget, Step One in the audit of a drug dealer
is to disallow every expense on the return unless it is
supported by meticulous documentation.

Upon determining the DD's gross revenue,it would be
appropriately malacious to make the GR available to
the State Sales Tax Auditors!

Dick

 

[Tom Healy CPA]

I did a little research on CA law, as that state has the largest number
of dispensaries, CO, my closest neighbor that has legalized it and my
home state of NM. CA law is quite clear that dispensaries must be
non-profit organizations. It also appears that you can't sell for cash.
(That's not to say that every dispensary is following the law.) I could
not find anything in CO law that requires the licensed establishment to
be nonprofit nor could I find anything in NM law that requires the
licensed producer to be nonprofit.

Here in CO dispensaries are having a hard time getting banks to allow
them to open accounts, because the banks consider the activity
illegal, and they want no part of it. That makes it difficult to
conduct the business on other than with cash sales!

 

[Alan]

Here in CO dispensaries are having a hard time getting banks to allow
them to open accounts, because the banks consider the activity
illegal, and they want no part of it. That makes it difficult to
conduct the business on other than with cash sales!

We're getting off topic.... however, the article below is
specifically about trying to make money selling legalized
marijuana in Colorado.

http://www.nytimes.com/2010/06/27/business/27pot.html

 

[Seth]

What's really annoying, is that if your hobby involves shipping your
inventory to people who pay for that, you must include the shipping
income in gross income on line 21, but you can only deduct the shipping
expenses on Sched A subject to 2%-of-AGI limitation (because it is not
part of COGS)....even if you simply pass along the shipping expenses
with no mark-up. Shipping can easily exceed the sale price of many
items produced as a result of hobby activities.

There is a way around that, if the buyer is willing: the buyer can
open an account with UPS or FedEx, and that gets used to ship stuff to
him. The seller never sees money, hence no income. (I don't know if
that would also work if the buyer sent the seller a check payable to
the shipping company; there's no constructive receipt because the
seller can't cash or depost it.)

Seth

 

[Kurt Ullman]

We're getting off topic.... however, the article below is
specifically about trying to make money selling legalized
marijuana in Colorado.

http://www.nytimes.com/2010/06/27/business/27pot.html

There is no such thing as legalized MJ. Feds have well and truly
pre-empted deciding what is and is not a legal pharmaceutical.

 

[Bill Brown]

  There is no such thing as legalized MJ. Feds have well and truly
pre-empted deciding what is and is not a legal pharmaceutical.

If there are any voracious, small-minded provisions in the Internal
Revenue Code, Congress put them there, not the IRS.