With tax day looming on April 15, Americans are busy exploring every possible opportunity for deductions on their tax return. But, before you consider deducting dog-related costs as a business expense, two important steps should be taken.
First, consult a professional tax advisor to guide you through the U.S. tax code’s tangled thicket of laws, schedules, and deductions. Second, consider one vital question which will help determine your path. Is your dog activity really a business or is it actually a hobby? Establishing the answer to that will determine what you can and can’t do regarding taxes and deductions on your dog business.
Business or Hobby?
The above question is crucial, because it’s the same one the Internal Revenue Service will also ask when they look at a tax return claiming dog-related expenses.
If you breed dogs regularly and, for example, show dogs to advertise your breeding business, all with the aim of making a profit, that’s a business. You shouldn’t be afraid to deduct your legitimate expenses in pursuit of your business goals, explains Jan Roberg, the founder and principal owner of Roberg Tax Solutions in St. Louis. But if you raised a single litter and sold the puppies in 2019 for the experience and to earn a little extra income, that’s a hobby. Either way, you must report any dog-related income to the IRS. However, hobbyists will not be able to deduct breeding-related expenses.
“Every year I get calls from people who just got a puppy and say, ‘I want to breed this dog,’ and they basically want to write off the cost of buying that puppy,” says Roberg. “But they’re not really professional dog breeders. It’s a hobby. The IRS is really cracking down on hobbies. So, if you’re going to claim your dog expenses, you’d better make sure that you really do have a business.”
That being said, even if you are running a business, the puppy you just bought isn’t a business expense yet.
“You can’t depreciate a dog or claim an expense for a dog until it’s of breeding age,” explains Roberg. “Until the dog is of breeding age, you can’t write off what you spent for that wonderful puppy. Save the receipt, and as soon as the dog is ready to breed, you can say you’re in the business of breeding.”
Be aware that claiming dog-related expenses can draw the IRS’s attention and skepticism. Keep your business records in good order to back up your claim that dogs are a business for you. For example, have a written business plan and a website. Keep advertising receipts related to the business. Maintain a separate bank account that is dedicated to your dog business’s activities. Don’t ever commingle accounts. Get a separate credit card strictly for the business. Don’t ever give in to the temptation to make a non-business expenditure on it.
“You want to show that you’ve dotted your I’s and crossed your T’s,” adds Roberg. “If you’re claiming you’re a dog breeder and you’re showing losses every year, you need to be able to prove that you’re really in it to make money and that it is a business, not a hobby.”
If your dog business is a business, treat it like one, and the IRS will see that seriousness of purpose. Roberg suggests considering setting up a limited liability company (LLC) or similar entity. If your dog activity is a hobby, you’ll simply need to declare any income from it—for example, from the sale of puppies—under “other income” on your taxes.
What’s New For Dog Businesses In 2020?
For those who do have a dog-related business, as opposed to a hobby, there are some changes to be aware of. If your business has a profit, for example, the most significant recent development is the qualified business income, or QBI, deduction.
“The QBI deduction is worth about 20% of your income as a deduction,” explains Roberg. “So, if you had, say, a profit of $10,000, you could get a $2,000 deduction off of your taxable income. If you have a business with a $100,000 profit, that’s a $20,000 deduction. That deduction can be pretty wonderful. It offsets your basic income but not your self-employment income. Most breeders are paying self-employment tax on that breeding income if they’re profitable.”
The QBI for profitable businesses is the most significant change. But there’s another one some taxpayers also should be aware of.
“For 2019, you’re not required to have health insurance,” says Roberg. “But if you did have health insurance and got it through the exchange under the Affordable Care Act, rather than through an employer, you still have to report it and do the paperwork on it.”
Tips For The Taxpayer
Set up a home office
Professional breeders often base their breeding business at home and claim a home office space as part of their expenses. But, home offices can also be useful for other professionals in the dog world, even if they perform their work off-site—such as training, handling, or grooming dogs—and even if their dog-related work isn’t their only job.
“Even if you’re not training at home, you want to have a home office for administrative purposes, because then you can claim your mileage,” says Roberg, offering her own dog trainer as an example. “Michelle comes to my house and works with my dog. If Michelle doesn’t have a home office for administrative purposes, she can’t claim the mileage she drives to my house. Technically that drive is a commute, and a work commute doesn’t count as a business expense. But if Michelle claims a home office, sending bills to me from her home or paying her training expenses from there, she can deduct her mileage from her house to my house. The office doesn’t have to be a whole room. Even a desk in the corner of a room can be an office.”
If you are claiming a whole room as office space, don’t keep your TV or a bed there, Roberg advises. If you’re only claiming a portion of a room, then a desk alone can establish a working base.
“It doesn’t even have to be a desk,” Roberg said. “I just did a tax return for someone who doesn’t have an office, but has a small storage area for his work supplies. You can have that, as long as you can prove that it is what you’re claiming.”
Hire your kids
Hiring your children as your business’s employees can save on employment tax, and it can have other benefits too. Children under the age of 18 working for their parents are not subject to self-employment tax on their wages. The standard deduction for singles has risen to $12,200, which means children can earn up to that amount without having to pay federal taxes. That earned income also can make your child eligible for a Roth IRA. They can put up to $6,000 of their earnings there, where it will grow tax-free. Depending on the state where you live, that can be a better deal than a 529 college-savings plan.
But remember, your child must genuinely be employed and working for the business. You must be able to prove that employment is legitimate. Keeping a record of the child’s hours and duties will help. One suggestion Roberg offers is to get your child a timecard.
Determine if your health insurance is deductible
If you have self-employment income and you pay out of pocket for your own health insurance—in other words, your health insurance isn’t covered by your employer—your health insurance is a deduction on your 1040.
“It’s not a deduction against your self-employment income, but it is a deduction against your business income on your 1040 tax return,” says Roberg. “Most people claim medical expenses on Schedule A when they itemize deductions. There usually aren’t enough expenses to deduct that way, but the self-employed health insurance deduction goes on Schedule 1, which gets deducted right off of your taxable income. You can deduct your self-employed health insurance up to the amount of your business profit.”
Don’t overlook deductions
Your business’s website, advertisements, office supplies, and phone service are all potential deductions. Keep track of these expenses and hand them in to your tax preparer. Expenses like Facebook ads count, as well.
Pay your taxes electronically
The IRS will accept your old-school paper check, but paying online at IRS.gov has important benefits.
“If you pay by check, the IRS will cash your check, but you never get a receipt saying you paid your taxes,” explains Roberg. “If you pay online, you get a receipt. Also, if you electronically file your tax return, the odds of getting audited are something like less than one-half of 1 percent. If you paper-file, your odds jump up to something around 5 percent. The other reason to file electronically is to prevent mistakes. If you electronically file, what you put on your tax return is what the IRS gets. If you paper-file it, someone opens up the envelope at the IRS office and then types your tax return into the system. There’s a possibility that they’ll type something wrong.”
Avoid Tax Tripwires
Tax filers who are listing themselves as professional dog breeders can already expect to come in for more scrutiny as the IRS tries to sniff out hobbyists seeking deductions. Legitimate businesses shouldn’t be afraid to claim deductions. However, it’s prudent to do what you can to avoid raising additional questions or red flags. Some of the potential tripwires that might give an IRS representative pause are pretty subtle. That’s another reason to confer with a professional tax advisor before going it alone.
“There’s a thing called Section 179, where you take something as a complete expense. Right now, there’s also a 100% depreciation. If you have a choice between claiming a 179 expense or depreciating, take the depreciation since it’s 100%,” says Roberg. “If you try to Section 179 expense a dog, that’s going to get looked at more than depreciating a dog. Even though, for all intents and purposes, you’re going to get the same deduction either way. Expensing a dog is going to get looked at.”
Some red flags are easy to avoid, like using round numbers for all your expenses. If your expense list reads exactly $2,400 for office supplies, exactly $1,000 for postage, etc., that’s likely to raise eyebrows for the computers that process tax returns.
“They go through computers, and if the computer sees too many zeroes, it pops that return out,” says Roberg. “Round numbers definitely get looked at, so don’t claim exactly 10,000 miles for your mileage.”
Finally, pay your taxes on time, even if you are applying for an extension. An extension is an extension of time to file, not an extension of time to pay. The penalty for late payment is one-half of 1 percent of the amount owed per month, up to 25%.