Thinking about starting a side hustle

[I Find This Humerus]

I'm thinking about making some craft projects on the side. I don't know how well the business will do but it if goes under I'll be financially ok still.

Cost of equipment would probably be a few thousand dollars initially and I'd be working out of my garage.

 

If I a form an LLC, my understanding is I can write off my business garage space as a home office (where I would work and store materials and completed projects) and also deduct the startup costs of tools, materials, website, advertising, etc. which will probably total to $5000 as a conservative estaimate.

 

I don't forsee earning $5k my first year unless I am very fortunate. So I assume I can deduct all of these things and operate at a loss for the first year?

 

If the business never takes off and I quit and dissolve the LLC, do I owe the deductions I took on next years taxes? How does this work?

 

Thank you, just trying to assess my risk here.

 

 

 

[jfoxcpacfp]

You don't have to form an LLC to take all of those deductions. You can deduct the part of your garage (sq feet method) dedicated to work. The area where you store materials can be multiple use (i.e. used to store personal stuff).

Startup costs of $5k is kind of squishy. Costs encompass your website, research, and other expenses that might not qualify for a direct write-off in the first year. However, some of those things can also be a direct write-off and do not need to be categorized as "start-up".

Yes, you can operate at a loss for the first year and following if you truly have a profit motive. If you quit and dissolve the LLC, you do not have to recapture the deductions but you might have some depreciation recapture.

I wish you luck - sincerely. If you start a crafts business and are profitable in the first year, not even counting the time you put in, I'd love to hear more about it. That would be extremely unusual.

[I Find This Humerus]

Yes I have to look into it more to do my homework before I dig in.

 

By startup costs I meant more material and tool costs, things that I have a good idea how much will cost. Advertising and such is more uncertain. But for example if I want to start woodworking, I know I will need about 3k in tools to do my work (saws, blades, bench, routers, clamps, etc.) and then the cost of supplies (wood, nails, glue, etc.) would depend on how much I work I would be doing. And this is even before I make a single sale.

 

I have a multi bay garage so I figured I'd just set aside one bay permanently for work, storage, etc. just for the side gig.

 

This may be a dumb question, but if I don't form an LLC, what prevents anyone who makes lets just assume $100,000 a year from buying let's a say a metalworking machine for $10,000 and writing it off as a business expense if there is no formed LLC business? Then giving up after the first year if no sales and essentially getting the machine at a discount?

Yes the machine lost value and could be sold used to recoup some costs but what if they wanted to keep the tools?

In my worst case scenario, no one buys my crafts and I'm stuck with a bunch of tools that I could hold on to for personal use or sell used to recoup some costs? But if I decide to hold on to them I don't have to give my tax deduction back the following year?

 

 

 

[jfoxcpacfp]

I Find This Humerus wrote:

This may be a dumb question, but if I don’t form an LLC, what prevents anyone who makes lets just assume $100,000 a year from buying let’s a say a metalworking machine for $10,000 and writing it off as a business expense if there is no formed LLC business? Then giving up after the first year if no sales and essentially getting the machine at a discount? Yes the machine lost value and could be sold used to recoup some costs but what if they wanted to keep the tools? In my worst case scenario, no one buys my crafts and I’m stuck with a bunch of tools that I could hold on to for personal use or sell used to recoup some costs? But if I decide to hold on to them I don’t have to give my tax deduction back the following year?

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You don't have to have an LLC to cheat on your taxes. People do that on a plain schedule C every day. The purpose of an LLC is liability protection, nothing more. If you have no risk of lawsuit from your crafts business, the LLC does not help you.

As for the metalworking machine, that is what I was referring to with depreciation recapture. I'm guessing the IRS allows such a machine to be written off over 7 years. The IRS also allows full depreciation in the year of purchase (there are other provisions) under Section 179 of the tax code. In this case, should the purchaser write off the full value in year 1 and cease business in year 2, and the machine be converted to personal use, she would be required to "recapture", as income, the extra 6 years of expense for the asset that was fully deducted in the first year. Typically, however, when people are closing down a business they either sell their assets (at a loss) or donate them.

Hope that makes sense.

[I Find This Humerus]

What do you mean by "cheat" taxes?

If I understand correctly, if I deduct the full $10,000 year one and I close down year two, I would pay back $10,000 x (6/7) = $8,571, or  1/7th the cost ($1,428) of the machine every year for the next 6 years.

So any other way to put it is each year I am still open for business saves me 1/7th the cost of the machine in taxes, up to 7 years.

[Larry Ragman]

This is implicit in what has been said so far, but don’t forget that one real tax issue here is to avoid being classified as a hobby rather than a business. If a hobby the IRS will disallow losses, and the IRS decides. Here is a quick link that summarizes some ways to avoid that classification even if you lose money. https://www.thebalancesmb.com/is-this-business-for-real-or-is-it-a-hobby-397675

[jfoxcpacfp]

I Find This Humerus wrote:

What do you mean by “cheat” taxes?

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By "cheat", I was referring to the scenario you laid out below:

I Find This Humerus wrote:

giving up after the first year if no sales and essentially getting the machine at a discount?

Click to expand...

The above would be cheating. You don't need an LLC to do it, though.

I Find This Humerus wrote:

If I understand correctly, if I deduct the full $10,000 year one and I close down year two, I would pay back $10,000 x (6/7) = $8,571, or  1/7th the cost ($1,428) of the machine every year for the next 6 years. So any other way to put it is each year I am still open for business saves me 1/7th the cost of the machine in taxes, up to 7 years.

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No, that is not correct. If you took a full deduction in year 1 and closed in year 2, you would be taxed on $8,571 recapture in year 2, not in the following years. An interesting result, though, is that, even if the original expense saved you SE taxes, you would not have to pay them back, only the income tax component, assuming your business has closed.

Just to be clear, the rules state that you are liable for recapture in any year the use of an asset on which you have taken section 179 drops below 50%. So, if you bought the machine 100% for business and then decided to convert it to mostly personal use in the following year, there would also be some recapture. You would not have to shutter the business to be affected.

[I Find This Humerus]

jfoxcpacfp wrote:

I Find This Humerus wrote:

What do you mean by “cheat” taxes?

Click to expand…

By “cheat”, I was referring to the scenario you laid out below:

I Find This Humerus wrote:

giving up after the first year if no sales and essentially getting the machine at a discount? 

Click to expand…

The above would be cheating. You don’t need an LLC to do it, though.

I Find This Humerus wrote:

If I understand correctly, if I deduct the full $10,000 year one and I close down year two, I would pay back $10,000 x (6/7) = $8,571, or  1/7th the cost ($1,428) of the machine every year for the next 6 years. So any other way to put it is each year I am still open for business saves me 1/7th the cost of the machine in taxes, up to 7 years. 

Click to expand…

No, that is not correct. If you took a full deduction in year 1 and closed in year 2, you would be taxed on $8,571 recapture in year 2, not in the following years. An interesting result, though, is that, even if the original expense saved you SE taxes, you would not have to pay them back, only the income tax component, assuming your business has closed.

Just to be clear, the rules state that you are liable for recapture in any year the use of an asset on which you have taken section 179 drops below 50%. So, if you bought the machine 100% for business and then decided to convert it to mostly personal use in the following year, there would also be some recapture. You would not have to shutter the business to be affected.

Click to expand...

I didn't realize a failed endeavor is considered cheating...

[jfoxcpacfp]

I Find This Humerus wrote:

I didn’t realize a failed endeavor is considered cheating…

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It's not.