Should my hobby income and matching expenses reduce my federal refund?

[RoperMom]

My daughter recently graduated from college.  Her first full year of the working world totaled $46,000.  She is single and rents a home in New Mexico.  This year she purchased a vehicle so I entered the sales tax as a deduction.  She also has college loan interest which I also entered in her return.  This year, she would have a tax refund of about $1,200.  However, she won $6,000 this year team roping, her hobby.  She has far more expenses than winnings.  She did receive a 1099-misc so I entered it as “Hobby income” and then the matching amount of expenses as “hobby expense”.  When I do this, her $1,200 federal refund drops to $237.  If the income and expense off-set each other, why would she loose $1,000 of her refund?  I notice this also dropped her State refund from $455 to $146.  Am I entering the income and expenses in the wrong place?

[DanielV01 · Accepted solution]

You are likely entering this correctly.  However, hobby expenses actually have 3 limitations:

• You may only claim hobby expenses up to hobby income (you've done that)
• They are subject to be reduced by 2% of AGI
• They are included with itemized deductions.  

So, if she had 6,000 of expenses, she must first figure 2% of her AGI, which is roughly 1,000. This is subtracted from her deduction, so she has about 5,000 in reportable deductions, and then these must be added with other itemized deductions.  When the itemized deductions are added together, maybe she gets 2,000 or 3,000 more of a deduction than if she took the standard deduction.  Filing single, her income (especially her hobby income) is being taxed at the 25% tax bracket.  If the difference between her hobby income reported on her return and the actual benefit is about 4,000 (very likely), then it is very possible that her refund is reduced by roughly 1,000 on Federal (and a similar reduction on state).

You and she should definitely be proud of her accomplishments, but these are the tax implications for classifying her winnings as hobby income (which is probably the correct designation).  However, click here for an IRS website that gives better information on this topic:  Hobby or Business IRS Offers Tips to Decide | Internal Revenue Service

[mesquitebean]

RoperMom wrote:  " If the income and expense off-set each other, why would she loose $1,000 of her refund?"

As TurboTaxDanielV explained, the income and expenses do NOT offset each other one-to-one.  Hobby expenses are quite restricted as indicated above, require Schedule A (itemized deductions) and difficult to take advantage of due to further limitations he outlined.