Hello, fellow shoppers. I just joined here and, being a tax preparer myself for the last 15 years, I was drawn to this thread. The first person who posted here gave a lot of good information, but there is one recurring misperception I have spotted that I would like to correct.
If you make a profit 3 years out of 5, the IRS will assume you have a profit motive and will not examine your enterprise to see if it is really a hobby. That is true. (But if the profit is $20 a year and the losses are $500 a year . . . don't expect to get a pass on that. Over time, the profit years need to outweigh the loss years.)
But it is NOT true that if you DON'T make a profit 3 years out of 5 that it will be automatically ruled a hobby, or even that the IRS will take note at all. It is possible, especially in this economy, to run several years of losses but still be able to prove that you are in business and trying to make a profit.
In order to establish your profit motive, it helps to do certain things: get a business license. Have a separate bank account for your business. Keep good records. Be able to show how you could have made a profit "if only" -- if only five of your shops done in good faith hadn't been rejected, if only your computer hadn't died and needed replacement, if only you had better timing to get good shops. You need to be able to show how much time you invested in the endeavor. Get an Employer Identification number and use that on your bank account with your business name (if you have one). ACT LIKE YOU ARE IN BUSINESS, not just dabbling in this to make a few extra bucks or get a free oil change now and then. They also want to see a business plan, where you have actually sat down and figured out how many shops you would need to do to make a profit, and how much time you can devote to the business to make it happen. If you're mystery shopping around a 40 hour a week job while raising a family, it will be harder to establish that you're in this for the money and not the free meals.
It won't do to tell the IRS agent, "I thought I was making a profit until I did my tax return and realized how much it cost me to drive to all those places," because that tells them you had no clue what is involved in running a business and you were just dabbling in this to make a few bucks and get some free tacos. You should have known in the first three months if you were making money or not.
So don't feel like you have to show a false profit to meet some arbitrary 3 out of 5 rule, if you truly are trying to make an income from this, not just get free meals now and then. Take your deductions, but also try to only do shops that will not ACTUALLY cost you money out of pocket. I only do shops if I have to go near the target for some other reason. I live 7 miles from town. I go to town every day to check my PO box. So I'll do a shop for $5 and deduct $7 in round trip mileage because I am actually gaining the $5 because I would have driven there anyway. My trip to the PO box became a writeoff because I was doing paying work at the same time. (Actually, it was a writeoff already for my other business. I may end up splitting the miles between the two enterprises.)
The other thing is that if you do not have a home office, the miles you drive to your first shop and the return miles from the last shop are NOT DEDUCTIBLE. So if you leave home, do one shop, and come back, the mileage is not a deduction if you don't have a home office. (Travel between business locations IS deductible; the home office becomes your first business location.) My mileage is deductible because I have a home office for my accounting business, which I also use to search for shops and fill out my reports.
If you are driving to do shops and can't deduct the mileage -- you really have a hobby because you will never make a profit that way. But if you're driving somewhere for some other reason and do a shop while you're there, you might have a profit motive. With gas $4 a gallon, be smart about it. And never forget that gas isn't the only thing that makes a car run.
The problem with the hobby is that unless you are already itemizing deductions, you will end up paying tax on the income and not get to deduct the expenses at all. Hobby expenses can be deducted up to the amount of the income, never to create a loss, but are deducted on Schedule A. So if you don't itemize, you'll pay tax on the full amount of income and not be able to offset the expenses at all. But the upside to taking the income as a hobby is that you don't pay the 13.6% (this year) Self Employment tax on hobby income, which may help make up for not being able to deduct the expenses.
Find a knowledgeable tax preparer to help determine the best approach. You may well find you are better off calling it a hobby than calling it a business.
If you make a profit 3 years out of 5, the IRS will assume you have a profit motive and will not examine your enterprise to see if it is really a hobby. That is true. (But if the profit is $20 a year and the losses are $500 a year . . . don't expect to get a pass on that. Over time, the profit years need to outweigh the loss years.)
But it is NOT true that if you DON'T make a profit 3 years out of 5 that it will be automatically ruled a hobby, or even that the IRS will take note at all. It is possible, especially in this economy, to run several years of losses but still be able to prove that you are in business and trying to make a profit.
In order to establish your profit motive, it helps to do certain things: get a business license. Have a separate bank account for your business. Keep good records. Be able to show how you could have made a profit "if only" -- if only five of your shops done in good faith hadn't been rejected, if only your computer hadn't died and needed replacement, if only you had better timing to get good shops. You need to be able to show how much time you invested in the endeavor. Get an Employer Identification number and use that on your bank account with your business name (if you have one). ACT LIKE YOU ARE IN BUSINESS, not just dabbling in this to make a few extra bucks or get a free oil change now and then. They also want to see a business plan, where you have actually sat down and figured out how many shops you would need to do to make a profit, and how much time you can devote to the business to make it happen. If you're mystery shopping around a 40 hour a week job while raising a family, it will be harder to establish that you're in this for the money and not the free meals.
It won't do to tell the IRS agent, "I thought I was making a profit until I did my tax return and realized how much it cost me to drive to all those places," because that tells them you had no clue what is involved in running a business and you were just dabbling in this to make a few bucks and get some free tacos. You should have known in the first three months if you were making money or not.
So don't feel like you have to show a false profit to meet some arbitrary 3 out of 5 rule, if you truly are trying to make an income from this, not just get free meals now and then. Take your deductions, but also try to only do shops that will not ACTUALLY cost you money out of pocket. I only do shops if I have to go near the target for some other reason. I live 7 miles from town. I go to town every day to check my PO box. So I'll do a shop for $5 and deduct $7 in round trip mileage because I am actually gaining the $5 because I would have driven there anyway. My trip to the PO box became a writeoff because I was doing paying work at the same time. (Actually, it was a writeoff already for my other business. I may end up splitting the miles between the two enterprises.)
The other thing is that if you do not have a home office, the miles you drive to your first shop and the return miles from the last shop are NOT DEDUCTIBLE. So if you leave home, do one shop, and come back, the mileage is not a deduction if you don't have a home office. (Travel between business locations IS deductible; the home office becomes your first business location.) My mileage is deductible because I have a home office for my accounting business, which I also use to search for shops and fill out my reports.
If you are driving to do shops and can't deduct the mileage -- you really have a hobby because you will never make a profit that way. But if you're driving somewhere for some other reason and do a shop while you're there, you might have a profit motive. With gas $4 a gallon, be smart about it. And never forget that gas isn't the only thing that makes a car run.
The problem with the hobby is that unless you are already itemizing deductions, you will end up paying tax on the income and not get to deduct the expenses at all. Hobby expenses can be deducted up to the amount of the income, never to create a loss, but are deducted on Schedule A. So if you don't itemize, you'll pay tax on the full amount of income and not be able to offset the expenses at all. But the upside to taking the income as a hobby is that you don't pay the 13.6% (this year) Self Employment tax on hobby income, which may help make up for not being able to deduct the expenses.
Find a knowledgeable tax preparer to help determine the best approach. You may well find you are better off calling it a hobby than calling it a business.
Time to build a bigger bridge.