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Hobby tax can be an expensive ‘lesson learned’

ALBUQUERQUE, N.M. — A good parent looks for “teaching moments.” He or she recognizes that kids do not respond well to lectures. Instead, provide children with opportunities for experiential learning and be there to offer counsel when opportunities present themselves to do so.

My mother, whose birthday would be this week, and who passed away earlier this year, had a special talent for this teaching technique. When I was young we got our first purebred dog – an English springer spaniel.

Mom thought her children helping to care for puppies from the moment they were born, blind and helpless, would be a learning experience. So we bred our dog and we had puppies.

My father, always the skilled craftsman, built a whelping box and, as fathers of that era did, bowed out of the picture. My sister and I were thrilled to take charge of the new puppies and help when the inexperienced mother was struggling.

This included hand-feeding two puppies too weak to nurse, even when it meant waking during the night to use an eyedropper to make certain that the “runts” survived. They did.

I was the lucky sibling – my elementary school was a 10-minute walk from the house. My older sister, then a sixth-grader, had a 15-minute bus ride to school. I was given special permission to come home at lunch to feed the puppies and clean up the whelping box.

As a new and unknown breeder, my mother worked hard to find good homes for the puppies. The vet bills were substantial, and a fee was paid to the owner of the father.

We lost money on that litter. How much I don’t know, but I do know that it was money that the family had little of at the time. But lessons can be costly.

I also knew my mother as a “rule follower,” one who once made me, at age 4, endure the indignity of returning to a dry cleaning store to return a wire hanger that I had walked out with.

My father was also a rule follower, with the exception of anything that involved a speed limit associated with an automobile or a motorcycle. So I am certain that, at tax time, my parents properly reported the income and expenses associated with the litter of puppies that they agreed would help to teach their children responsibility.

The tax law has a long history of “proper” reporting of non-business activities. These are often called “hobby loss” rules.

These are the rules. Report all gross receipts on the first page of the tax return. Then deduct all expenses as itemized deductions, limited to the income reported on Page 1, and then only the expenses that exceed 2 percent of your adjusted gross income.

Wow! All for some puppies? Yes. So let’s say that the receipts from puppy sales are $3,000, and the expenses are $2,000. You made a profit! But let’s say your AGI is $50,000. Your real profit is $1,000. Your “tax” profit is $2,000 (you lose $1,000 of expenses from 2 percent of your AGI).

Let’s say the expenses are $4,000. First, you can only use $3,000 – — limited by the gross receipts. But you again lose $1,000 of these expenses due to the 2 percent rule. So you report $2,000 of expenses and therefore $1,000 of net income (and you really lost $1,000).

Well, it gets worse. Beginning in 2018, you can’t deduct any of these 2 percent expenses. So the puppy sales are income, but no expenses are allowed. That’s an expensive lesson.

You could say the puppy activity is a business – then all expenses are allowed on the first page of the tax return. But for my mother, that was not true. And I know she would pay the tax price of her kids’ lesson rather than report wrongly.

Many years later I find this tax result unfair. But I also appreciate an anonymous quote from a person who may have, like me, been raised for experiential learning: “Learn a lesson from your dog. No matter what life brings you, kick some grass over that s*** and move on.” My mother lived her life like that – maybe that fueled her kinship with dogs.

Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.

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