Tax Time: Hobby Expenses and Federal Tax Law

From the JK Lasser's Tax Guide:

There is a one-way tax rule for hobbies: Income from a hobby is taxable as "other income" on form 1040; EXPENSES ARE DEDUCTIBLE ONLY TO THE EXTENT YOU REPORT HOBBY INCOME, and the deduction is limited on Schedule A by the 2% adjusted gross income (AGI) floor for miscellaneous deductions. Hobby losses are considered NONDEDUCTIBLE PERSONAL LOSSES. A profitable sale of hobby collection or activity held long term is taxable as a capital gain; losses are NOT deductible.

Therefore, if you don't show hobby income you cannot show hobby expenses on your tax return. There is also a whole "presumption of profit-seeking motive" involved. If you have a model building business you can, and should use a Schedule C (Unincorporated Business / Sole Proprietors) declaring all your income and your expenses. I'm not saying that if you paint a Belldandy for someone that you can expense your FSS collection. But all the supplies you buy for the business of building models can be expensed (paints, glues, etc) and you can depreciate your assets (airbrush, compressor, spray booth, etc) or section 179 expense them in the first year. If you are not profitable in 2 of the last 5 years they IRS may reclassify your "business" as a hobby and will follow the rules quoted above.

The states with personal tax returns (that leaves out our friends in FL and TX, and probably others that I am not aware of) usually follow suit.

Just to clarify, if you have a model commission business there are three ways to account for it:

1. Schedule C Sole Proprietor / Unincorporated Business. Claim all income and expenses attributed to your business. The net number goes on line 12 of the Federal form 1040. (It's also Social Security Taxable!)
2. Other Income. You declare the GROSS (full amount earned without expenses) on the OTHER INCOME line, line 21 on the 1040, then any expenses incurred are taken on the Sch A (Itemized Expenses). This isn't as good as #1, because you can't net it out. You add the expenses on your "Other Expenses" line of your Sch A which are subject to the 2% floor (your "other expenses" must exceed 2% of your AGI). If your income level isn't too high, you may not have enough expenses to itemize. You need more than your standard deduction. So you'd be out of luck on that. This is probably the most complicated way to show your activity.
3. Stick the cash in your pocket and keep your mouth shut.

I think most use method 3. ;)