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07-24-2017 11:02 AM
So I received a letter from the IRS saying I understated my income by $53k. They are saying I owe $24k.
Basically, I threw a large New Years party, and everyone payed $120 to get in. Open bar, 2 bands, the works.
I didn't make any money off the party. It's just something I enjoy doing. The money came in to a PayPal account I set up.
What are my options to get this alleviated? I can come up with invoices showing where most of the money went, but not all of them.
Sad thing is. This is on my 2015 return. I have thrown 2 parties since then of similar size that they will probably also find out about. No way can I afford to pay for any of this.
Any advice is greatly appreciated.
Solved! Go to Solution.
07-24-2017 07:25 PM
Welcome to the H&R Block community.
It certainly sounds like you intended this to be more of a hobby when you started doing it, but it kind of has become more of a business activity. Hobbies generally don't bring in $53,000 in revenue. I can see why the IRS would sees this as a business activity. Even if this is a hobby though, meaning that there's truly no intent to make money & you only do it because you enjoy doing it, the revenue still has to be reported as hobby income on Line 21 of your 1040 return.
The IRS is calculating $8,109 in FICA taxes on the $53,000 in revenue from your parties and the remainder is federal income tax based on all of your income combined. So that's where the $24,000 due is coming from.
The good news is that I can get you out of this if you follow the advice that I'm about to give you. What we need to do is show the IRS that you didn't actually earn any income, and we do that by deducting expenses.
Businesses only pay tax on their NET income, which means income after deducting expenses. So what you can and should do is set this party throwing business up as a sole proprietorship. You'll complete a Schedule C with your tax return that will show the revenue you received and then you'll deduct your expenses from the revenue on the Schedule C. If you don't have any revenue left over after you deduct your expenses then you don't have any income and you won't owe any tax. If you had more expenses then you had revenue then you'll have a business loss and that loss will offset the other income on your tax return. Also, if you set this up as a business and keep good records the IRS will be less likely to question it than they would be if you were to report $53,000 in revenue as income from a hobby.
If you do want to make some money at this then just raise your entry fee enough to turn a small profit for yourself and that profit is all that you'll pay tax on. For example, if you bring in $60,000 in revenue but you had $50,000 in expenses then you will only have to pay tax on $10,000. Tax on $10,000 is about $1,000 plus about $1,530 in FICA (social security & Medicare) taxes. Both can be reduced by claiming credits & deductions elsewhere on your tax return though (FICA can be reduced only by refundable credits and excess withholdings from other jobs).
If this is truly a hobby then there is another option, although you would have to be able to prove that this is a hobby because the IRS will likely ask. If you report this as a hobby then you would report the income as hobby income on Line 21 of your 1040 return. Your expenses are deductible in the miscellaneous section of Schedule A to the extent of the income from the activity. So if you made $53,000 then you can deduct up to $53,000 worth of expenses on Schedule A. When you use Schedule A though you do not get a standard deduction because your Schedule A deductions take the place of your standard deduction, so if you were to deduct $53,000 worth of expenses on Schedule A then you would actually get a total deduction of $46,700 over what your standard deduction would have been so you likely will not be able to reduce your tax on the income from these parties all the way down to zero if you report this as a hobby.
I'm sure that Paypal sent you a Form 1099-K showing all of these $120 payments. Payment processing companies are required to issue this form if you bring in over a certain amount. The revenue shown on the 1099-K normally goes on a Schedule C (if reporting as a business) just like income shown on a 1099-MISC would.
The most important thing here is to keep records of everything. Make sure you keep a log of all of your expenses and get a receipt whenever possible. The receipt serves as absolute proof that the expense occurred and the log serves as additional evidence of the expense. I would write down the name of the vendor you used, the type of expense, the date, and the amount spent for each expense that you incur in your expense log. If you have that kind of a log and those receipts you'll be able to take on an IRS audit and come out on top.
So again, I recommend reporting this as a sole proprietorship on Schedule C. From the information you provided you have enough expenses that you will not owe any tax on this income once you've deducted everything. You can deduct the items that you don't have a receipt for, but again create a log of your expenses as best you can for this time around even if you don't have all of your receipts for your previous parties.
If you have any other questions I'll be glad to help.
Senior Tax Advisor (Tampa, FL)