Dive Master income and taxes

[ranpar01]

I know this is a very boring thread, but any input is greatly appreciated. I'm just wondering how other Divemasters are handling their income taxes and if they are deducting gear and expenses on a schedule C? For now I'm just going to have a little bit of income from doing discover local scuba and refreshers, but I'm planning to go on for AI and instructor eventually, so this is going to be a business for me. But not my main source of income. Just curious to hear what approach others are taking income tax wise? I'm getting paid on a 1099 through the LDS not W2.

thanks,

Randy

 

[ClayJar]

From what my dive buddy the CPA tells me, unless it's a *significant* source of income (I don't recall the precise fraction by which that's judged), it counts as a *hobby* and the expenses are *not* deductible. Basically, if I were to work on a boat as a DM, I could claim all the diving expenses, but since my "real" job pays *far* more than diving ever would (short of being a full-time-plus instructor), if I keep that job, I can't claim any of the diving expenses. It doesn't matter that I'm getting paid to be a DM or Instructor. If it's not a *significant* source of income (relative to your total), the IRS just smiles and says it must be nice getting some money from your hobby.

(This is not to say that people don't, but if you get audited, you may end up paying quite a bit in taxes, penalties, and interest.)

 

[AzAtty]

I disagree that DM work is a hobby. You must seek specialized training for it. The certifying agency touts it as a professional level certification. You must carry insurance. You must pay license fees to your certifying agency. You perform services in exchange for money. A LDS sends you a 1099 for services you provide. All of those are hallmarks of a for-profit business activity.

In a "I'm claiming my hobby as a business" situation, the taxpayer attempts to deduct expenses arising out of the hobby and claim them as business losses on Schedule C to reduce the taxpayer's adjusted gross income. The classic case of this where I live is raising Arabian horses. Also, in most cases hobbies do not generate income at all, so if there is a hobby-ish activity with lots of deductions but no income, that raises a red flag. And in some cases you have to capitalize start up expenses rather than deduct them immediately, so sometimes you don't get an immediate deduction for certain expenses.

The amount of time spent performing an activity is typically relevant to determine whether the activity is a "passive activity." If a for-profit activity is a passive activity, the taxpayer may not use losses generated by passive activities to offset income from "active" businesses. In other words, you can create all sorts of losses in passive businesses, but it won't do you any good when your other sources of income are active businesses.

"Passive activities" are those business activities in which the taxpayer does not materially participate. A classic passive activity was the old real estate limited partnerships that every doctor and dentist bought into during the 1980s. Until the law was changed, the LPs would depreciate the daylights out of the property, run up huge paper losses, and pass the losses on to the limited partners. The limited partners could then set off those paper losses against real income to reduce their tax liability. Not surprisingly, nowadays real property leasing is a per se passive activity.

I typically advise clients that they should show a profit in three of five years of conducting the activity. The IRS presumes the activity is for profit if you turn a profit in three of five years.

The way I would handle it is in years where you have income, deduct expenses directly related to producing that income. Don't claim expense deductions in excess of the amount of income produced (that's the "pigs get fat, hogs get slaughtered" rule). And turn a small profit during a few years. A couple bucks isn't going to change your tax bracket, most likely.

EDIT: I should note that I would NOT attempt to deduct ALL of the expenses you incur in pursuit of scuba diving (like new gear for general use, all your trips, etc.). Deduct only expenses legitimately related to your DM work.

 

[ClayJar]

Many good points, AzAtty. (Not like you need me telling you that, but hey. :biggrin

I typically advise clients that they should show a profit in three of five years of conducting the activity. The IRS presumes the activity is for profit if you turn a profit in three of five years.

Indeed. The "3-of-5 Rule" (or 2-of-7, in the case of horses... sadly, not seahorses) is the most straightforward way. If you pass that test, you don't have to worry about the arduous task of convincing the IRS that you really *were* doing it to try to make a profit.

Considering the line "Activities you do as a hobby, or mainly for sport or recreation, are often not entered into for profit.", I wouldn't want to press the IRS on the issue. If you're spending a lot in years 1 and 2 but you're going to turn a profit in years 3-5, I believe that would be Form 5213 (to put off the for-profit determination until year 5), but I'd hate to see the look on the IRS' proverbial face if you didn't turn three years of profit and they decided you were really a hobbyist.

 

[chgodvr]

From what I've been told by tax preparers, unless you are turning a profit, don't worry, it is still a hobby. Keep track of what you earn as a divemaster and what it costs you to be one. Until this becomes a major source of income, it is still a hobby.

 

[Peter Guy]

From what I've been told by tax preparers, unless you are turning a profit, don't worry, it is still a hobby.

While a wonderfully succinct rule, it is NOT the law!

AzAtty did a pretty good job of providing the "conservative" advice relating to the OP's question. The REAL question is do you want to act conservatively with your taxes or aggressively? Me, I prefer to act aggressively and see what happens!

That said, FOR ME, my rule has been -- As long as there is a colorable claim, I'll claim it! That is, I won't do fraud but I'll deduct everything for which I can come up with any justification. Here's my reasoning:

a. Something less than 5% of all tax returns are audited -- and those are pretty good odds in my favor

b. Of those 5%, most are either very high income (with shelters or other complex returns) or (believe it or not) very low taxable incomes (but with very high deductions/credits). It is actually approaching 1% (or less) of the total returns that are audited of "normal" taxpayers. Those odds are VERY good that my return won't be audited -- so I opt for aggression.

Now, back to hobby vs. a "business." For the last 15+ years I've happened to raise horses in addition to my "real" job. After NOT taking the deductions (as suggested by my then CPA) I got a new CPA and told him I wanted to be aggressive and treat the horses as a business. We then refiled two years worth of returns and got audited -- and were blessed by the IRS.

Now, had we shown a profit? No way! (At least on a cash basis.)

Had we shown that we were likely to show a profit in the near future? No way! (Again, at least on a cash basis.)

The key however, was NOT that we had shown, or would show, a "profit" but that we were IN GOOD FAITH ATTEMPTING TO MAKE MONEY!

People too often think the 3 of 5 or 2 of 7 rules are requirements -- they are not. They are presumptions used by the IRS to determine if the activity is being done in good faith to attempt to make money.

How do you show a good faith attempt? By how you run the business:

Do you have a reasonable business plan?

Do you have the skills necessary to run the business?

What are the reasons for the losses?

Remember, Amazon didn't make any money for years but no one said IT was a "hobby."

Everyone has an obligation to pay the government every cent of tax that is owed per the law-- but not one penny more!

 

[AzAtty]

This is one of those cases where my advice is "do what I say, not what I do." What I didn't say in my first posting is that in my own businesses, I did exactly what Peter did in his--aggressively take deductions (yes, including scuba equipment) and roll the dice on an audit. BUT YOU SHOULD NOT DO THIS!! YOU WILL DIE IF YOU DID WHAT PETER AND I DID!!

I rarely advise clients to do what I have sometimes done, because (a) I take calculated risks and know how to mitigate them better than the client, and (b) the client will sue me if he does what I did but has a negative outcome. Sometimes the dice come up with snakeyes on the come out roll.

 

[Peter Guy]

YOU WILL DIE IF YOU DID WHAT PETER AND I DID!!

Hmmm, my doctor wife tells me I'll die anyway -- it's just a matter of time!

 

[ranpar01]

Thanks guys, this is good stuff. My accountant said basically the same thing as AzAtty, suggesting I play it conservative (to cover his own ass) but stating that we're free to lose money in this country in business ventures if we want to. So he said if it is a busines, run it like a business, and take your deductions as such. For 2007 I'm not going to do anything because I didn't have much income and was very disorganized. But now in 2008 I'm going to organize things a lot better and launch it as a dive business. I've got a website, Tahoe Divers Main, and will put together a business plan to lay out what I'm going to do. For example, I'm also planning to become an AI this year so I can have more income potential from running more programs. I'm also sellling some drysuit talc seal-saver products for shops or others that want to use them for maketing. Thanks again for all the input!

PS - if you are interested in the talc product for your shop or dive business let me know. What I do is put custom labels on little talc bottles, which can either be resold in your shop or given away at DEMA or other conventions.

 

[Divin'Papaw]

Divemaster income ... what the heck is that?