At the end of Ima Hobbyist’s first year providing freelance writing services for her friend’s business, she receives a Form 1099-Misc in the amount of $750. As indicated in our last blog this document confused Ima Writer and she called her friend and asked for more information. Her friend refers her to her own account who tells Ima Writer that as a business owner her friend was obligated to report all money spent for services and expenses related to her business. Furthermore, because the amount for the year was more than $600 it required the issuance of the Form 1099-Misc.
Per the last blog, Ima Writer went to the IRS website to download and review the pertinent material that her friend’s accountant referenced and concluded that she was indeed earning the money as a hobby and not as a business. Ima Writer has no intention of making a profit and she doesn’t know if she will even continue to pursue writing for anyone else, even a friend, but in the meantime she has to make sure that she properly files her federal and state individual tax returns.
Because the 2013 federal and state tax forms are not yet available, Ima Writer decides to see what impact the $750 she earned would have on her 2012 tax return in an attempt to better understand the tax consequences of earning income as a hobby.
Ima Writer’s 2012 tax return was a 1040EZ and she earned $35,000 from her day job as a copy writer for a local small business. She loves her job because she loves writing and even though her salary isn’t as large as if she commuted to the city, she enjoys her options to telework and to potentially earn money writing on the side. She hasn’t made up her mind about the writing-on-the-side thing because what she really wants to do is write fiction. She has started what she hopes is the Great American Novel (GAN) but right now it’s just a dream. This recent twist of earning money as a hobby and having to claim it as income has her realizing that she must have a better understanding of the business side of writing before she goes any further.
After poking around on the IRS website, Ima Writer realizes that there are three levels of the Form 1040 for an individual’s federal tax return. Until now she has enjoyed the fact that her return has been fairly simple to prepare and that she has been able to use the 1040EZ. She now understands that because of the hobby income she must use Form 1040 which is the more complicated version of the three choices.
Ima Writer transfers her 2012 tax information to the Form 1040 and adds the $750 to line 21 of Form 1040 listed as Other Income. She sees from the instructions that she will have to indicate that this is hobby income. She recalculates her tax and realizes that if she had earned this amount of money in 2012 her federal tax liability would have increased by $112.50 due to the fact that her tax rate on this income for 2012 is 15%. She must also pay whatever her state tax rate is on this income. If her state tax is 3% then she would owe an additional $22.50 to the state as income tax on the money earned.
At this point, because she has earned the money as a hobby, she is not able to reduce the amount by any expenses that she had. That would come later on the Form 1040 Schedule A which we will discuss more next time.