So, you have a new puppy and are intending to show it to its championship and then establish a breeding program with that new star! Great idea, but you need to know a lot of tax facts before you decide that you are in the business of breeding future champions.
The Differences Between a Business and a Hobby
The Hobby Trap: Whether your endeavor is a business or a hobby, any income from sales of your production is reportable and taxable. If you breed only one litter, you are engaging in a hobby, but the sales of your puppies/dogs must be reported, usually not subject to Self-employment taxes, as Other Income on your personal tax return. For tax years 2018 through 2025, expenses related to hobby income are not deductible.
On the other hand, if you intend to be classed as a business, there are many rules that must be followed.
The Business: Organize and act like you are in business with a profit motive. If the activity is considered a for-profit business, deductions can exceed income, allowing the resulting loss to offset other income. Factors indicating a business include maintaining a complete and accurate set of books and records, operating similarly to other profitable activities, and changing operating methods and techniques to improve profitability as needed.
Separate bank accounts for the business are a must. I suggest to my clients that forming an LLC both protects other assets from legal disputes arising from your sale of dogs and is an indication that they intend to be a business. A single-member LLC is still ignored for tax reporting, as you use the same Schedule C on your 1040 as before for tax reporting. If there are profits in the business, you can transfer funds from the business account to personal accounts as needed, as you will be taxed on the profit, so it is your money – after tax.
Your expertise in the business and the amount of time and effort you spend in it counts toward the profit motive. Even if you spend little time, it will not be counted against you if you have qualified hired employees to carry on the activity.
Occasional profits, if any, earned in relation to the amount of losses, and in relation to the taxpayer’s investment in the activity, may indicate intent. An occasional small profit in one year, mixed with large losses in other years or large taxpayer investments may indicate the activity is a hobby. Substantial occasional profits mixed with frequent small losses or investments may indicate a business.
If the taxpayer does not have substantial income from other sources, the taxpayer may have a profit motive. Conversely, if the taxpayer does have other income and the losses from the breeding activity generate substantial tax benefits, there may not be a profit motive.
The IRS Rules state that if an activity is profitable in three of the last five years, including the current year, the presumption is that it is carried on for profit.
Other Good Information
Employee or Independent Contractor? If you hire people to help you run your business, be mindful of the Employee or Independent Contractor rules. A worker who is key to the success of a business is more likely to be controlled by the business, which indicates employee status. On the other hand, a temporary assignment, with the worker making his or her services available to other businesses, is likely an independent contractor. An employee gets a W-2 for their services; the Independent contractor gets Form1099NEC for those services of $600 or more in a year.
Business Use of Home: The business percentage equals the area of the part of the home used for business divided by the area of the whole house. Any reasonable method may be used. Common methods are the square footage as indicated in the first sentence above, or if all rooms are the same size, divide the number of rooms used for business by total number of rooms in the house. A third “safe harbor” method – that means it will not be disallowed by IRS – is based on $5 per square foot of home used for business, limited to 300 square feet.
Direct expenses that benefit only the space exclusively used for business are fully deductible. Indirect expenses that keep up and running the entire home are deducted based on the percentages as above.
Vehicles – Business use: Your car or truck used in your business can generate deductions for your business. If your office is in your home, travel from home to another place of business for the same business is deductible. Using the standard mileage rate eliminates the need to keep track of actual costs. For 2023, the rate is 65.5 cents per mile. This rate covers the actual cost of depreciation, lease payments, maintenance and repairs, gasoline, oil, insurance, and vehicle registration. It does not include Auto Loan interest, Personal Property Tax, or parking fees. Those costs are also deductible.
You must have substantiation for your mileage for business. If you have a smartphone, download one of the apps that tracks your mileage and allows you to input your reason for the trip. These allow you to keep a contemporaneous record: Exactly what the IRS requires.
Travel, Lodging & Meals: Travel expenses include the ordinary and necessary expenses incurred by you, generally for overnight stays, while on temporary travel away from your tax home for business. Meal deduction is allowed, limited to 50% if incurred while traveling or while entertaining a client or customer. For 2021 and 2022, businesses will be allowed to fully deduct (100%!) of business meals provided by a restaurant. Recordkeeping is required for the meals, as to date, who attended, and the purpose of the meeting.
So, the moral of the story is: Intend to be profitable, adjust operations and supplies as necessary to improve profitability, keep complete and accurate records, and cross your fingers that you do not run afoul of the IRS!
Tax Day is fast upon us, and Betty Ann Brown, a CPA (pictured above with her Cavalier King Charles Spaniel) who is a long-time fancier and an AKC delegate for the Hendersonville (NC) Kennel Club, offers some valuable tips. Keep reading for her advice on getting your taxes done as painlessly as possible.