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Thanks Danny - didn't think about inventory - never had that kind of business before. Helpful thanks.

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Thank You and Best To All

"I don't see anything wrong with a hobby writing off expenses. If I understand correctly, if you sell a guitar you built, you need to report that as income. If those are the rules, then why not write off the expenses against it?"

Whisperer mentioned that you can write off your hobby expenses up to the amount of your hobby income. It's right there with Slots and horse racing!



I 'believe' that what that effectively means is that you can neutralize any income you make, so that you don't have to pay extra income tax...

I build strictly as a hobby. My day job is as an attorney specializing in setting up, selling, investing in, or liquidating out of closely held businesses.

I won't give any legal advice for your situation, but my experience is that the IRS rules are stacked against small businesses. You can be the most profitable corporation in the history of the United States (Exxon Mobil 2010) and pay NO income tax whatsoever, but a own a small shop somewhere an expect all kinds of computer generated scrutiny.

IRS computer are designed to flag loses on schedule C but have virtually no oversight on large 1120 returns.

Are you planning on filing a Schedule C for your guitar business? Are you going to file a dba with your county, get a
local business license? Can you prove your marketing efforts? Does your state or municipality charge a business tax on your business assets?

Assuming you have an effective rate of 25% and you spend $2-3k a year on guitar building, is the hassle worth the $800 tax savings?

Not for me.


Sent from my iPhone using Tapatalk

I build for myself. After awhile I ether sell em or burn em. The ones I burn are a POS. The ones I sell I've grown tired of. Kind of like selling a car is the way I look at it.

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Say what you do, Do what you say.

Here's some advice. (Not legal advice. Just friendly neighbor advice.)

(1) The potential tax savings we're talking about is a lot more than the $2-3k year you spend building guitars, which rlrhett describes. There's a LOT more than that. If your efforts are properly classified as a business rather than a hobby, then you may be able to deduct all of the following even if they exceed your income from building guitars (of course, don't take my word for it; talk to your tax professional to see whether these would apply to you):
(a) The money you spend on materials.
(b) Depreciation on your existing tools.
(c) A Section 179 deduction for the entire cost of any new tools.
(d) A depreciation deduction for the percentage of your home that is dedicated to guitar-building.
(e) A proportionate deduction for any amounts you spend to repair or maintain your home, based on the percentage of your total square footage dedicated to your guitar-building business.

There are plenty of others, but these illustrate the fact that the potential deductions can be significant.

(2) Don't assume that your efforts are a hobby simply because you would ordinarily describe guitar-building to your friends as a hobby. The IRS's definition of "hobby" is not the same as the one you might normally use. The IRS says your effort is a "hobby" if it is not engaged in for profit. So, the fact that you do it primarily for fun doesn't matter. The fact that you hardly make 30 cents an hour doesn't matter. The fact that you aren't very good at it so you often don't make an actual profit on some guitars doesn't matter. What matters is whether it is "for profit." There are lots of guys on this forum who would probably describe themselves as hobbyists, and their primary motivation is fun, but they are selling guitars and trying to make a profit on the ones they sell (even if it's a very small profit). Talk to an accountant before you assume that you are just a hobbyist and that you miss out on the good deductions.

(3) Even if you decide not to call yourself a business for now, by all means, declare some profit on your taxes every year. Even if you have enough deductions to totally offset your guitar-building income, don't take all of those deductions, and allow yourself to pay taxes on at least some guitar-making profit. The reason for this is that, three or four years from now, you might consider calling yourself a business and taking all the deductions that may more than offset your guitar-building income for that year. If so, that track record of making a profit for several years may be a helpful factor in establishing that you have earned the right to call yourself a business.

Of course, talk to your tax professional.

The best advice I will give you is this

The only advice that is good advice is what you get from your LAWYER and ACCOUNTANT . EIN you may need one even if you don't have employees. Get a CPA for your book keeping . You run a lower risk of audits and in most cases the advice will save you a lot more than what you pay for it. Hobby business is ok for a short while then you may graduate to a DBA ( doing business as ) Corporations will help you separate business from personal estate in case you get sued . Also it make your business depending on the size easier to do business.
If you purchase over a certain amount , there will be a 1099 issued to you buy the people you do business with , this can raise a red flag. Also Paypal is required to report any one doing more than $10,000.00 of money movement through their system.
Use every chance you can to keep what you make use milage , insurance , everything you can to keep what you deserve. Depending on what you want to do , it takes money to make money.

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John Hall
blues creek guitars
Authorized CF Martin Repair
Co President of ASIA
You Don't know what you don't know until you know it

That is the best advice you should listen to. Situations and location are different for all of us and no one here can advise you properly so Johns advice is sound.



Unfortunately that is not the case John. After I graduated from college and worked at Stow Davis for almost 3 years as a designer I left and started my own design consulting business. The accountant I hired told me that as well so I incorporated. After getting some other bad advice from her I fired her and hired an accountant that also had a law degree. He immediately told me that if I was sued they would go after the corporation first and me second so I was not really protected. He also showed me that I was paying double taxes on my income so switched me over to a LLC. I found out very quickly that I was making more money and rather than relying on the "corporation" to protect me, with the money I was saving I was able to purchase liability insurance that would give me real protection.

Now granted that was back in the late 80's so the laws may have changed since then but that is what learned then.

Other than that one point, Very good advice John.

Cheers,
Bob

Here is a great link to the SBA (small business administration (United States)) (<===== note nested loop...) describing what an LLC is: http://www.sba.gov/content/limited-liability-company-llc

Although technically inaccurate lots of folks believe LLCs to be corporations because in the "limited liability" sense they are very similar. Note the language in the link regarding liability where it says "Limited Liability. Members are protected from personal liability for business decisions or actions of the LLC. This means that if the LLC incurs debt or is sued, members' personal assets are usually exempt. This is similar to the liability protections afforded to shareholders of a corporation. Keep in mind that limited liability means "limited" liability - members are not necessarily shielded from wrongful acts, including those of their employees."

So there is limited liability with LLCs but not shielding from wrongful acts. If you Google "wrong acts" in the legal sense you will see that the limited liability afforded by an LLC does cover the vast majority of things that can happen when folks are making legitimate and honest attempts to run their businesses.

What is also very attractive about LLCs at least to me besides the limited liability is that the company is not taxed by the Federal government and instead the profits, however distributed with the LLC's "members" are taxed as personal income and the term "flow through income" applies.

We, meaning our business in Ann Arbor is an LLC and of course we just completed a tax cycle, filed our return, and the profits were distributed throughout the year to our members and then we paid personal income taxes on this distribution.

Forming an LLC, since we just did it last year, was not very difficult at least here in Michigan.

Common sense also tells us that there is only so much liability that one can possibly encounter endless toiling by candle light with sharp chisel.... For the real concerns theft, fire, etc. that's what quality insurance is for as Bob said and ours is with Heritage.

I got into this to work with guitars and in my case I have spent WAY too much time in my past dealing with the financials of a corporation so we have a great accountant on retainer who also does our taxes. We also have a book keeper working for us doing the daily entries and we use QuickBooks and it works fine for us. And we have an attorney who's office is just across the street a few door down from the marijuana dispensary... who is also a friend and collector of vintage guitars. Reminds me of "Alice's Restaurant" in the "you can get anything you want" sense....

Anyway an LLC was a great fit for our business and I can spend my days working on instruments and not dealing with the drudgery of small business management.

Excellent description of a LLC Hesh. Far Better than I could have explained it. I am really not the business type and pretty much follow what my accountant says. When I was doing Product Design I also needed a lawyer so I I was fortunate to have found my accountant who also had a law degree and happen to be a very honest and decent guy. He steered me in the correct direction of getting rid of the "inc." and into the LLC which was a good move for me at the time.

The simplest way to do a business/hobby is a DBA (Doing Business As) and you can file your taxes just as personal tax which is a very simple way to do it but you should look into what your state tax laws are for setting it up. Again, John's Halls advice is the best advice you can get. Let the people that know there stuff tell you what is best.

As for Insurance, I would highly suggest everyone MUST have some kind of insurance. The insurance I was talking about in my other post was liability insurance because I was a design consultant helping people design products. But insurance against fire, theft or damage is really a no brainer especially if you have a separate shop from your home. If you have a shop in your home like I do then you should talk to your insurance agent and make sure they are aware of the equipment you have. They will probably add a rider on your policy just for your shop but the cost will be well worth it if something terrible should happen. Especially if you are running a business from your home since you could run the risk of having your insurance company cancel your complete policy or worse decide not to cover you if something bad did happen and you burned down your house.

So even if you do not start and LLC, INC, DBA, or are just a Hobby, Insurance is an absolute MUST unless you don't care if you loose everything and have to start over from scratch.

That is my 25c worth...

Bob

In a one-man luthiery business, you won't get any meaningful liability protection out of an LLC, corporation, partnership, or any of the above. The reason for this is that, in all likelihood, anything you would get sued for would be based on something you personally did. Corporations, etc. do not shield you from liability for things you personally do. They shield you from liability the corporation has based on the mistakes that others in the corporation make, but they do nothing to stop someone from suing you for your own conduct.

Kelby,
I am not a lawyer but I have had a Corp and an LLC and I don't think that is quite correct.

If you started Kelby Inc. then you are an employee of that Corp. The Corp pays you as an employee of Kelby Inc. If you build a guitar and lets say someone is playing it on stage and fall off of the stage smashing the guitar and driving a piece of the split soundboard into his side and ruptures his spleen. He takes Kelby Inc to court and says the reason he fell off stage is because the strap button broke off and he tried to catch the guitar. The guitar had a manufacturing default in it because the top split when he fell. The lawyer makes a good case of it and wins a $100,000.00 judgment against Kelby Inc.

The first place that $100,000.00 will come from is Kelby Inc. assets. Any money you have in the name of the Corp will be gone, then they will remove any other assets from the Corp such as equipment and inventory. If Kelby Inc. does not have enough assets to cover the judgment then they will come after the share holders which would be you unless you are deemed to be only an employee of the Corp in which case you would have no liability in the matter. If you are the president and main shareholder then you will be next in line to have assets removed.

Maybe someone that knows more about law could correct me if I am wrong...



As I said, I am not a lawyer but that is how I understand a Corporation and an LLC to work. I think the LLC makes you a bit less liablel but liable non the less.


Bob

Hi Rob,

I am a lawyer. Been practicing over 20 years. Feel free to look me up.

Generally, a corporation's shareholders are not liable for the corporation's debts or liabilities. That's the primary purpose of having a corporation or an LLC. If the corporation doesn't have enough assets/insurance to pay an injured party who sues, then the injured party is out of luck. The one significant exception is if the shareholders are the corporation's "alter ego." This means that, if the shareholders don't treat the corporation like a real company, and if the shareholders instead treat the corporation's assets as their own, the the shareholders may be considered the corporation's "alter ego" and may be liable for the corporation's debt. But if you treat your corporation like a separate entity -- separate bank accounts, no co-mingling of funds, adequate capitalization, have regular board meetings, etc. -- then you are shielded from your corporation's liabilities. Bottom line, unless someone can prove you are your corporation's alter ego, you are generally NOT liable for your corporation's debts and liabilities. If someone told you that the shareholders get stuck with whatever liability is left over after the corporation has no assets, then you got some bad advice.

Now, one other exception would be a scenario in which you have engaged in conduct that would make you personally liable separate and apart from whether your corporation is also liable. So, for example, suppose you are an employee of a corporation. In this hypothetical, let's say it's your own corporation. And let's say that your corporation needs you to run an errand to Home Depot to pick up some glue. On the way, you inadvertently run a red light and crash your car into someone else. In that situation, you personally did something that would make you liable -- you negligently drove your car into someone else. The fact that you were working for your corporation as an employee at the time does not get you out of liability. Your corporation may also be liable, because an employer is liable for an employee's conduct that is within the course and scope of the employment. If driving to the Home Depot was done in an employment capacity, the corporation is also liable. This means that the injured victim could sue both you and your corporation.

Or, let's say you tell a customer that you will have their guitar finished by June, and it takes until December. The customer sues for fraud. Assuming that sort of thing constitutes fraud, you would be personally liable, since you personally made the representations. Your corporation would also be liable, since you made the representations in your capacity as an employee of your corporation, and corporations are liable for the conduct of their employees within the course and scope of their employment.

This last exception is the important one for a one-man lutherie shop. Generally speaking, most lawsuits would probably be based on something that you personally did, which means they can sue you personally. If you negligently break their guitar, or you misrepresent something, then they can sue you personally whether you are an employee of your corporation or not. If a customer trips and falls in your garage workshop, they are going to claim that you left a tripping hazard in your home, even if your corporation also uses your home. One exception would be that the customer cannot sue the employees for breach of contract or breach of warranty, because those are the corporation's liabilities alone. But those claims will typically be small, and that's not what most luthiers are worried about when they try to set up a corporate shield to protect their assets. That's why I would express some reservations about the utility of having a corporation or an LLC, both of which involve paying franchise tax fees and neither of which get you very much protection against the types of large lawsuits most luthiers might see. But of course, I'm not your lawyer, and you should consult your own legal counsel about your specific situation.

One more thought: On the question of whether corporations/llcs give you much protection against liability, I would be wary of getting advice from an accountant, even if they also happen to have a law degree. (Law school doesn't teach as much as you might think.) Almost every time I had a client get sued on an alter ego claim, the client almost always protests, "but my accountant said . . ." Accountants are good at accounting and taxes. They should probably stick to that.

@Kelby,
Thanks for clarifying that. If you are a lawyer then you must surely know.

I guess I got my info based on your first assumption because when I ran my design consulting business I was the owner/operator and only shareholder. I didn't think of myself as a shareholder but my lawyer (not my accountant) told me that when I hired a sales person I could treat her like an employee or let her buy a percentage of the company and she would share in the profits. But I was told that If I was sued I could be liable so that is why I bought liability insurance. It was my accountant/lawer that suggested I switch from a corporation to an LLC.

So I guess I was my own company's "alter Ego"

But either way I had my design consultant business for 15 years and never got sued so I guess something went right...

Thanks again for the explanation, Even though it veered slightly off topic it still adds to the discussion of starting a business for tax write offs.

Cheers,
Bob