A photographer is still in school full time but is already establishing connections for professional work. She is purchasing cameras, lenses and equipment she will use in her career. She paid a professional designer to create her logo, business card and web site. She has had one small paid job so far and is scheduled to shoot an event in a month for which she will invoice and be paid for her work.
Can she deduct the costs of marketing (web site, logo, business card) and equipment on her income taxes?
It depends upon if she is demonstrating a profit motive.
Profit motive is the intention of making a profit. Motive is the reason behind one’s actions. If you are in business, it is assumed you want to make a profit.
With creative freelancers, the issue as to whether someone is running a business or doing a hobby can be a concern. Art, design and photography can easily be considered hobbies, not businesses. In fact, many clients would prefer that we do our work for the love of it alone and don’t care about being paid. However, we have the right to earn revenue and make a living via our talents, and if we choose to do so, we need to go about it correctly so that we can earn a living.
If you have a profit motive, you must show intent to make a profit. This does not mean you must make a profit in order to claim deductible expenses. It is for this reason that, in Freelance Road Trip, I walk you through the step-by-step process of setting up your business and the putting necessary legal frameworks into place. The frameworks help to protect your livelihood from hobby-loss designation in case of a tax audit. These are some ways that demonstrate you are seriously running a business:
If you obtain a business license, you may be engaged in business.
If you have a business plan, you may be engaged in a business.
If you have business checking, savings and credit lines, you may be doing business.
If you file a DBA, you may be setting up a business.
If you join (by paying dues) a chamber of commerce, you may be engaged in business.
If you pay self-employment taxes, you may be running a freelance business.
If you set up accounting and bookkeeping software with income and expense categories that relate to the Schedule C, you may be creating a business.
If you distribute business cards, you may be promoting a business.
If you receive money in exchange for your creative services, you may be running a business.
If you are spending time regularly marketing, networking and pursuing client leads, you may be building a business.
If you collect and remit sales taxes on tangible goods, you may be running a business.
If you set fees for your work, write contracts, and register copyrights, you may be engaged in business.
If you have a marketing plan, you may be creating a business.
If you have a web site that says “Hire me for your next corporate portrait photo session”, you may be promoting a business.
If you create a business, you may have a profit motive.
If you just like to create stuff and you occasionally sell something, you may be a hobbyist.
Hobbyists may be able to deduct certain expenses, but only to the limit of what they earn from their hobby. If a hobbyist earns $300 in a year they can deduct only up to $300 of hobby-related expenses. You cannot claim a loss from a hobby.
Profit Intent and Reality
The IRS (United States) understands that there is a difference between profit motive and profit actuality. In general, it allows 3 consecutive years of loss. But profit motive is more than making a profit on your business efforts. The IRS looks at everything you do for your business, not just at income and expenses. It can take several years for a self-employed independent creative to create a profit. 3 profitable consecutive years out of 5 means there is a profit motive according to the IRS. In the 4th year, if you’re still not showing some sort of a profit ,you may be considered a hobbyist, and your expense deductions could be limited. So you need to keep things in profit motive mode. This is especially true if you are freelancing part time while employed.
If you are carrying on your work with the intent of making a living or adding to your income — i.e., you are engaged in trade or business — you demonstrate a profit motive even if you show a loss in a given year or for several years in a row.
The IRS’ 9-item checklist for establishing a profit motive
How you run your business. Are you focusing on making money? Are you keeping records? Do you invoice? Are you licensed? Are you doing what businesses do?
Do you have the necessary skills? Expertise is not only about being an amazing designer, but about being an amazing business owner. Are you actively engaged in learning how to run your business? Being a member of Freelance Road Trip is one way to learn this. Additionally, most hobbyists do not earn degrees or certificate in their hobby. If you have have studied and matriculated, such as our photographer friend, or earned a certificate in the area of your freelance work, that shows motive for earning a living as a professional.
How much time do you spend regularly and actively engaged in working on your business? If you freelance as a side gig while being a full-time or part-time employee, the time you spend may be significant in determining if you are in business or doing a hobby.
How likely are you to profit in the future? If you sold your business in the future, would you profit from the sale? Freelancers don’t have a lot of assets compared to small business owners with a shop, employees and big equipment. What are you doing now, where are you investing time and money to ensure revenue over the long term? Photographers can sell and license their photos, illustrators can sell their paintings and drawings, and designers can sell their designs. The more revenue channels you develop (selling prints, licensing images, selling templates, etc.) the more likely you are to create consistent revenue streams.
Past related success. Have you owned or do you own other businesses that have turned profits?
History of profit and loss. if you’ve been freelancing for some time and have shown a profit consistently in the past, a few bad years will not necessarily relegate you to hobby mode. If you are just starting out, you need to build, gain momentum and put systems in place to be able to turn a profit in the near future.
Occasional profits. Freelance income ebbs and flows. If you earn a substantial creative fee on a single project, that occasional profit may be substantial enough to show profit motive. By having 1 or 2 large revenue sources (mega projects) it can offset the rest of the year when you’re not earning much.
Is freelancing your only source of income? If so, you are considered to be in profit motive mode. If you freelance part time while employed, you cannot rely on this criterion alone.
Personal pleasure. If your business is not generally considered a source of personal pleasure or recreation, the IRS will consider you to be in business to make a profit. Now, self-employed creative independents engaged in illustration, photography or design do what they do because they both enjoy it and want to earn their living by it, even though these disciplines are also common hobby pursuits.
You don’t need to meet all 9 criteria in order to be deemed a business owner, but you should establish your profit motive on as many of them as possible. Remember, it’s not a business until you treat it like a business!
Given the current landscape and the myriad opportunities for freelancers to thrive, there is reduced potential that you will be considered a hobbyist for income tax purposes. Even so, take the 9 points from the IRS, take a look at your freelance business, determine where you need to make some “profit motive” changes, and make those changes. Discuss your situation with an accountant or tax attorney.
Profit Motive Required to Claim Business Deduction
Activities Not Engaged In For Profit (PDF)
Business or Hobby? The 9 Factors
DISCLAIMER: I am not an attorney or CPA. This information is offered in good faith for general information purposes only and is not exhaustive. It is not intended as legal advice or opinion. I do not make any warranty about the completeness, reliability, or accuracy of this information. Any action you take based upon this information is strictly at your own risk. I am not liable for losses and damages in connection with the use of this information. You should seek legal and other professional advice when establishing or conducting a freelance business.