Can I form a sole proprietorship or LLC selling self-made guitars in order to tax shelter income from my day job?

The short answer is "yes". But be sure to make a profit within one of the first three years or so in order to convince the IRS that this is not a hobby.

As Mr. Halverson stated, you run the risk of having the IRS classify your business as a hobby. In order to legitimately claim losses, you must be trying to make a profit at the business. Section 183 of the tax code disallows losses for activities not engaged in for profit.

You can create a sole member LLC that will report the income you make from manufacturing and selling these guitars. Of course, the business's income and deductible expenses will be reported on your individual Schedule C for Form 1040, but the business can be a separate legal entity as an LLC. This isn't a "tax shelter," but rather would protect your personal assets in case your business accrues a liability that it must pay, and vice versa. If you continue operating at a loss for several years in a row, the I.R.S. may attempt to classify your business as a hobby, thereby greatly reducing the types and amounts of expenses that you can deduct as business expenses. So long as you are actively trying to obtain new business and reduce your overhead costs, this shouldn't be an issue, but it is something that you should be aware of in case you find yourself still reporting a net loss years into the business.

First, you should definitely set up a limited liability company rather than act as a sole proprietor. Reasonable startup expenses would be deductible. Obviously, you are in this to make a profit CU must keep very good records. At mean you should have copies of all receipts for anything purchased and you should use and online accounting system such as QuickBooks. If you are serious about the business, and establish website, social media marketing, and other things to market your guitars, that will also demonstrate that you are in this as a business not a hobby. As a guitar player myself, I am amazed at the large influx of cheap Chinese guitars that are competing at the low end of the price spectrum. Also, the guitar market has dropped significantly over the past several years. Vintage guitars have declined in value. There is still a good demand for high quality custom crafted guitars. Who knows, in the next two years you might become the new Paul Reed Smith! I suggest that you discuss this with a good tax and business lawyer to set up your business correctly. Good luck! Ron Cappuccio