Taxpayers frequently have income reported on Form 1099-MISC. It may represent earnings from a trade or business that should be reported on Form 1040, Schedule C. If not, it generally is reported as other income on Form 1040. Of course, net income from a trade or business is subject to both income tax and the 15.3% self-employment tax, while other income generally is subject only to income tax.
However, while taxpayers can deduct a net operating loss from a trade or business, they may deduct their expenses incurred in generating other income only up to the amount of that income. Consequently, tax preparers must be able to determine whether income is trade or business income or other income, which isn’t always easy.
TRADE OR BUSINESS
A trade or business has been defined as “holding one’s self out to others as engaged in the selling of goods or services.” (Deputy v. du Pont, 308 U.S. 488 (1940), Frankfurter, J., concurring). The Small Business/Self- Employed section of the IRS Web site at irs.gov defines it as “an activity carried on for a livelihood or in good faith to make a profit.” Revenue Ruling 58-112 further characterizes a trade or business activity as one that is regular, frequent and continuous. The regularity of activities and transactions and the production of income are important elements. Taxpayers do not need to make a profit to be in a trade or business as long as they are able to earn a profit and have a good-faith motive to do so. They must, moreover, make ongoing efforts to further the interests of the business.
REGULAR, FREQUENT AND CONTINUOUS ACTIVITIES
These activities were held to constitute a trade or business because of their frequency:
- A member of Congress was paid $1,500 during a year for 10 speaking engagements. The frequency showed “a degree of recurrence, continuity and availability” (Revenue Ruling 77-356). However, Revenue Ruling 55-431 states that “as a general rule, an individual who accepts an occasional invitation to make a speech … is not engaged in a trade or business.”
- A person was paid for giving blood plasma 95 times in a year (Green v. Commissioner, 74 TC 1229).
Some income-generating activities are deemed infrequent enough to constitute other income. Revenue rulings (58-112, 55-431 and 55-258) indicate that income from an occasional act or transaction, absent proof of efforts to continue those acts or transactions on a regular basis, are not income from a trade or business. Some examples of income-producing activities that were infrequent enough to escape being classified as a trade or business include:
- An assistant professor coauthored a book without any obligation to later work on revisions. The fact that she did revise the textbook five years later did not matter (Langford v. Commissioner, TC Memo 1988-300).
- A man created and patented inventions in his spare time (Levinson v. Commissioner, TC Memo 1999-212). The Tax Court held that he was not in the business of inventing because he did so only sporadically.
- A commercial fisherman leased his fishing permit after he became ill and unable to fish. He intended to do so only sporadically (Chief Counsel Advice 200321018).
- A corporate officer received a fee for negotiating an isolated sale of all the company’s stock. He did not regularly hold himself available to the public for negotiations (Revenue Ruling 58-112).
- A man participated in a clinical drug study for which he was paid a lump sum. His intent was to receive treatment for asthma (Private Letter Ruling 9106004).
In most instances, if the nature of the earnings does not appear to constitute a trade or business, the CPA tax preparer can make a case for reporting the earnings as other income and therefore avoid the cost of self-employment tax. The trade-off, of course, is that ordinary and necessary expenses of producing other income can be deducted only up to the amount of the income.
By Jennifer Spiesz, MBA, of Fargo, N.D., and Charles Harter, CPA, Ph.D., professor of accounting, Georgia Southern University, Statesboro, Ga. Their e-mail addresses, respectively, are email@example.com and firstname.lastname@example.org.