Friday, August 29, 2008

Our Wonderful, Wasteful IRS

OK, so the IRS spent $42 million this year to notify tax payers that they needed to file a tax return to get their income redistribution payment from Uncle Sam. Fine.

So in June this year the IRS notified me that my 2006 Tax Return was being examined. I had claimed $7000 in 1099-misc income as Hobby Income. The IRS claims that it's not a hobby based on the fact that the income was in box 7, and since it was in box 7 it was subject to Self Employment Tax (more commonly known as Social Security). For those of you who have never worked for yourself, the government takes almost 15% of Self-Employment income right off the top for Social Security and Medicare. When you work for someone else, you only pay half of this and your employer pays the other half. However income from a hobby is not considered Self-Employment income, and therefore not subject to Self Employment Tax.

So this is where my beef with the IRS lies. Is my work for a Hobby (not subject to Self Employment tax) or is it a For Profit Business (subject to Self Employment tax)?

I thought long and hard about this because more often than not the IRS forces people running businesses to file as hobbies. The following was my response to the IRS:

Dear Ms. Lunnon:

With respect to our enclosed examination, the IRS contends that my Not For Profit Activity (otherwise known as a Hobby) was actually a For Profit Business, i.e. that I am self employed. This was due to income reported on line 7 of a 1099-MISC form for the Tax Year 2006. It is my contention that the issue boils down to whether or not the Activity I was engaged in was done For Profit. On our 2006 return I claimed it was a Not For Profit Activity (Hobby), and I stand by this assertion. I put a lot of thought into this and I did so based solely on the IRS’s own information about how to distinguish between an Activity done For Profit (Business) and an Activity done Not For Profit (Hobby). I know the IRS often looks into whether or not an Activity claimed as For Profit is really a Not For Profit Activity, so I paid particular attention to this information.

Firstly, I would like to note that the key difference between Hobby income and Business income is the intent to make a profit; not whether a profit was made. Just because I make money from a Hobby does not mean that I am self-employed or that I am running a Business, regardless of how said income is reported to the IRS. Further, Self Employment Tax is only required if the Activity is carried on as a trade or Business. In my case it is not, my Activity is carried on as a Hobby.

Secondly, I would like to make clear the following points:
I am not a contractor - there are no written contracts involved.
I do it for fun and enjoyment with no profit motive.
I don't do any advertising or marketing - I don't even have a Business card.
I do similar work for free, just for fun.I don't run my Hobby as a Business.
I spend between 60 and 120 hours a year on my Hobby; sometimes maybe a bit more and sometimes less.
The amount of money I receive is not a significant part of my income and I am not trying to increase or maximize it. I can stop it at any time with no significant financial impact.

In summary, it is quite clear that this Activity is engaged in for recreation and is not engaged in For Profit – even though a profit was made. Since this is the case I argue that my income is a result of my Hobby and should be treated and taxed as a Not For Profit Activity. I therefore am not liable for, nor should I be required to pay, Self Employment tax.

The IRS finally responded last week in classic fashion - they sent me FOUR copies of the same letter in TWO different envelopes stating that they would get back to me by Sept 27th. We'll see how this pans out. I feel my argument is solid and I feel I could win with a good lawyer, but it wouldn't be worth it for me to pay to go to court. If at some point that's my only recourse, I'll simply pay the SE tax and move on. Sadly, that's how this government works. Taxpayers have little recourse against a wasteful, erroneous IRS.

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