THE MILLIONAIRE DENTIST PODCAST

EPISODE 48 TRANSCRIPTION

Announcer:
Hello, everyone. Welcome to the Millionaire Dentist podcast, brought to you by Four Quadrants Advisory. On this podcast, we break down the world of dentistry, finances and business practices to help you become the millionaire dentist you deserve to be. Please be advised, we do speak with an honest tongue and may not be safe for work.

Casey Hiers:
Hello and welcome. This is Casey Hiers back at it. I want to start off by asking our listeners a question. Are there any topics out there that you would like the Millionaire Dentist podcast to address? If there are, by all means, let us know, bring it to our attention and we would love to potentially tackle some of those in 2021. Well, I am pleased to announce that we have two very special guests back in studio with us today. Colt Smith, who is a tax expert, as well as Steve Levy, who is an attorney and a CPA. Gentlemen, welcome.

Colt Smith:
Good to be back, Casey.

Steve Levy:
Thanks, Casey.

Casey Hiers:
Steve, what more could you ask for then joining our podcast on your birthday?

Steve Levy:
Perfect, perfect way to spend my birthday.

Casey Hiers:
Now you can make a new wish because this wish came through.

Steve Levy:
Exactly.

Casey Hiers:
Well I'm looking forward to our topic today. I'm just going to go ahead and set it up for everyone. Many practice owners and practice owners' spouses, they're passionate about other activities. And a lot of times those activities, there's expenses to them. There's time associated with them, but there can be income or revenues associated with those activities. And what I mean, we see it from public speaking, to maybe a horse business and everything in between. And so what we're going to do today is talk about anything you're spending time on that you're incurring expenses to do and revenue or income is coming in, even if it is a hobby and it's a passion, it needs to be accounted for in a tax perspective and be looked at more like a business. That's the setup, a business versus a hobby. And Colt, will you help our listeners out by just defining the difference between the two, especially from a tax perspective?

Colt Smith:
Absolutely. A business is a livelihood activity to make a profit. A hobby is exactly how it sounds. It's something that you do on the side that you're not necessarily trying to earn a profit for.

Casey Hiers:
And we know a lot of practice owners that they're passionate about their hobby activities, but they can be expensive. My hobby, I may go and hit some golf balls or shoot baskets, but we see a lot of activities or hobbies that there's considerable expenses with. Is that you'd agree with that?

Colt Smith:
That's absolutely correct. And that's something that I wanted to talk about was the importance of defining what a business is versus a hobby. Is you need to talk to your financial team on these types of sideline activities that you have, because if something is a business versus a hobby, there are different ways to show that on your tax return and with a hobby, you can't take losses or expenses. And so it's something that you need to be in communication with your financial team for so they can advise you on how to treat that sideline activity, that side hustle as a true business. There are plenty of factors which we'll get into here shortly, but that is kind of the main point of this is to kind of show what the importance is between a business and a hobby.

Casey Hiers:
Steve, let me ask you this question. You've got a practice owner, he loves flying. He wants to get a pilot's license. He wants to get a plane. It's his passion, it's his hobby. Let's say he owns a plane and let's say he may be rents it out. Let's say he maybe transports some people and get some income around that. Is the worst thing that can happen as somebody at the end of the year comes to you and says, "Hey, Steve, I'm so excited. I'm doing this new thing, my pilots license, I've got a plane, I'm doing some things." Does your mind instantly go to, oh boy, expenses and income, did you have a lot of it this year that would just wreck your taxes?

Steve Levy:
Yeah. I guess some of what we see is that we didn't know about it in the first place and oh, we need to report that income, but then they'll say, "But I spent all this money. How can I possibly have reportable income that'll boost my taxes from this?" We want to sort of guide them as to the rules where they can treat it more business like and be able to capture it for a possible tax benefit.

Casey Hiers:
Let's peel the onion back even more. Are there clear characteristics or factors that determine if the activity is a hobby or a business?

Colt Smith:
Yeah, so per the IRS, there are generally nine factors and we're not going to get into the complete 100% technicalities that go along with it. It's more so a question and a play along of how the factors work out. The first one is, do you carry on the activity in a business like manner? Are you doing record keeping? Are you keeping separate bank accounts? That sort of thing. Are you putting in a reasonable time and effort indicating that your profit was intended? Do you depend on that activity for your livelihood? Business is livelihood activity to earn a profit. That's a big, important factor. Are the losses in your business due to circumstances beyond your control? That could be startup costs you talk about with the plane activity. Do you change up your methods of operation to improve your profitability? Are you actually trying to earn more profit? Do you or your advisors have the knowledge needed to carry on your successful business? Is everyone in the know of kind of what's going on? Were you successful in making a profit with similar activities in the past? How many years have you shown profit?
For most businesses, it's you're supposed to show profit three out of every five years. Whereas a horse business, as we discussed earlier could be two out of seven years. And can you expect to make a future profit from some sort of appreciation of assets from the activity that you're performing?

Casey Hiers:
You mention that there's a lot of factors there. Who can help determine the business like activity versus the hobby like activity and then how to properly document these things? What do you suggest from that regard?

Colt Smith:
To maximize that sort of activity, you need to talk to your financial team, whoever that may be. They can guide you on what you should be doing for bookkeeping, record keeping, track your hours and time and effort that you're putting into it. Have documentation and support for any expenses that this activity incurs, but for the most part, yeah, the main subject is talk to your financial team. They will guide you and help maximize the expenses that can help decrease any income that you are receiving to make sure that it is considered a business and not a hobby.

Casey Hiers:
Well, hobbies and expensive hobbies and something you're passionate about, those are great. But what you don't want that to do is then negatively affect your tax situation or all the fruits of your labor at the practice and all that you're producing and collecting. You don't want an unknown to come in and wreck the taxes. We alluded to it earlier, Steve. End of the year, you learn something that you should have known earlier. And for anybody that has a hobby that they're passionate about, they need to treat it like a business and they need to document things and they need to talk to their team and make sure that the whole picture is accounted for not just this one. Steve, if it is a hobby, how is income and expenses reflected on a tax return? Or talk about how that needs to be accounted for.

Steve Levy:
Yeah. If it's a hobby, there's lots of limitations there. First of all, for income, it's just reported as miscellaneous income on the front page, basically. For expenses, it used to be that you could take the expenses as a miscellaneous itemized deduction, it's like where you'd put your tax prep fee or things like that. But that's no longer the case as of starting in 2018. Any hobby expenses you just can't use. And that's why we want to steer you towards more business like, than not.

Casey Hiers:
To be a business, what constitutes income? And does that need to be shown on annual tax returns?

Steve Levy:
Well, whatever income you make, you have to report. Just plain and simple. For the expense side, like I said, there's just lots of disallowances there. Most of the time for hobby, it's just not going to help at all.

Casey Hiers:
Are there instances where there's hobbies that, for example, if somebody was working with us, we would encourage them to change, tweak or adjust it because it's just crushing them from a tax perspective or financially. Let's pivot into that a little bit and talk about times when maybe the advice is you need to look at this hobby because it's wrecking your finances.

Colt Smith:
Yeah. There's been instances where people may be sell beauty products or selling nutritional items where we want to know, hey, so how long you been doing this? How much money you been making? We could be keeping books for you monthly, just like we do your practice and making sure things are streamlined that way. And on top of that, it's important to know that if you're doing this stuff out of your home, you can get a home office deduction. What's the square footage of the room that you're using predominantly for your office? And these are just things that if we don't know the expenses that you were incurring doing this activity, your income could be inflated and could cause some sort of tax surprise, especially if you're making quite a bit of money with it.

Casey Hiers:
Tax surprise, the crux of this entire topic. Nobody wants a surprise. Nobody wants something they weren't accounting for. And for better, for worse, a lot of times these hobbies or other activities, they can creep up. Guys, any parting words for our listeners regarding this topic of a business versus a hobby and how it relates tax wise.

Steve Levy:
Well, I think in general, if you are doing this passionate hobby that you're putting a lot of money into, there doesn't need to be extreme changes to really convert it into a business where you're getting income and expenses and getting the tax write off just like your practice. If you steer it more to how you're approaching your practice, then it opens it up for a more businesslike treatment. You have a separate checking account. Think about the things that you do for your business, how you're treating that. If you steer your hobby more towards that, then you could be looking at even a tax benefit.

Casey Hiers:
Well and we know practice owners who they're in a band or they like to do comedy and they'll actually do sets and they'll get income from that. And so while minor, that needs to be factored in into your taxes.

Steve Levy:
Exactly. And you're driving all around for that expensive hobby. The mileage is a really major expense you could be taking on that. Plus maybe some of your hobbies require a certain special license to be able to do this. Maybe a membership here and there or royalties, that kind of thing. There's lots of expenses that you could capture.

Casey Hiers:
Well, and the spirit of this is again, constant communication with your team and no surprises. And we've seen a whole bunch of very interesting hobbies and areas practice owners spend time in, but again, if there's any money involved in it, account for it, document it, talk to your team because that can affect you at tax time. Guys, I appreciate it. Thanks for joining us today.

Colt Smith:
Thanks for having us.

Steve Levy:
Thank you.

Announcer:
That's all the time we have today. Thank you to our guests for their insight and for sharing some really great information. And thank you to you, the listener, for tuning in. The Millionaire Dentist podcast is brought to you by Four Quadrants Advisory. To see if they might be a good fit for you and your practice, go on over to fourquadrantsadvisory.com and see why year after year, they retain over 95% of their clients. Thank you again for joining us and we'll see you next time.