I have talked with numerous accountants/CPAs/EAs who have looked thrilled at the thought of “firing” a client. Usually, once business picks up, they will fire their problem clients. But the question you might have is–what if you’re the client who was fired?
Final section! We’re almost there.
I.) Elements of personal pleasure or recreation
While I hate to beat a dead horse, a lot of businesses I’ve seen disallowed have to do with something that started out as a hobby. Do you garden and sell your plants at a farm stand? Are you a antique collector who sells antiques on eBay? A while back I posted a quote in Do you have to suffer for your business? where I mentioned that the Tax Court has actually mentioned in a a ruling that suffering doesn’t have to be part of a business in order to make it a viable business. One thing to keep in mind is that if you do breed poodles and refer to them as “your babies” in the court, your chances just got a little smaller of claiming that your kennel is an actual business.
And with that…I’m done! Next series–freelancing businesses and it’s many intricacies. See you tomorrow.
G.) The amount of occasional profits, if any, which are earned
This falls into the previous categories where the question was about the success of the business. Are you making money in this business? There is a 3-out-of-5 rule where the cannot be losses for more than 3 years in any given timeframe. An additional qualification might be–do your gains in the non-loss years exceed the losses in the years you have a loss? There are a couple of tax court cases out there that cover this. I’ve seen a case where the court ruled that the taxpayer did not have a business simply because, while they had gained $15,000 between the two gain years, it did not exceed the losses in the three loss years which totaled $40,000. The ruling stated that the business was a hobby because the profit would never allow for the business to break even over the five years.
H.) The financial status of the taxpayer
This is a tricky one. They want to know if this is just a rich person’s hobby. If you get into breeding prize poodles and you just keep losing money at it (by giving the puppies away to friends or selling them inexpensively) seemingly have losses to offset your income, the IRS will take that into consideration. It’s basically asking “why are you doing this? Is there a loss motive to your ‘business instead of a profit motive?’” Believe it or not, much like tax shelters, some folks invest into ‘businesses’ in order to have a loss.
E.) The success of the taxpayer in carrying on other similar or dissimilar activities
So you own a doggie daycare–does that really qualify you to run a dog training business? This is an example of what the IRS might ask when it comes to similar ventures. Keep in mind that you might be able to make a really strong case that two seemingly unrelated businesses are related and that your success in one shows that you have the knowledge and skill to carry on the other in a successful manner. If you’ve been a successful IT network technician then you may be able to say that you would make a great PC hardware technician and that you could make a go of it.
F.) The taxpayer’s history of income or losses with respect to the activity
The one thing that stands out in my memory of audits with this is a guy I worked with who was a horse breeder. When he had profits, they were spectacular, when he had losses…well, I would have cried. A LOT. They seemed to balance out pretty nicely–you could easily argue to the IRS that the losses and gains balanced out to a net gain–which was a point in his favor during the audit. However, there is a three-in-five rule (with exceptions for horse breeding) where you can only have a loss three out of five years that the business is in operation. Any more than that–there is a chance of audit because it looks like the activity wouldn’t actually be a business but is a hobby that’s not pursued for profit.
C.) The time and effort expended by the taxpayer in carrying on the activity
Oh the stories I can tell you about this one! The biggest culprits? Gamblers, sadly. Numerous Tax Court cases involve folks who don’t pursue their business as if it were a job time-wise. How many cases talk about the person who just made a little money on a hobby and decided to take a business loss because they picked up all their expenses (thus violating hobby rules.) Again, this falls into the first topic–that the business should be carried on as a business and not as if it’s a hobby. You put time into the business as if you want it to succeed and be profitable.
D.) Expectation that assets used in the activity may appreciate in value
Back to the auto restoration business as an example–you have to expect that the vehicles you’re working on will be worth more money when you’re done than when you start with them. (Considering the condition of most restoration candidates, that shouldn’t be difficult!) The assets, items belonging to the business, produced by the business, or used by the business might increase in value with the continued use or development. You’ll notice that this one line states that the assets “may appreciate” this one in particular is meant to be a guideline, not an absolute. There are plenty of businesses out there where all the assets lose value because they’re consumed in the processes that businesses employ to make money (using a sewing machine to assemble designer handbags doesn’t make the sewing machine more valuable, for example.) This is one of the guidelines and if your business’s assets don’t increase in value but you meet all the other criteria, you’re probably fine.
A.) Manner in which the taxpayer carries on the activity
Are you acting like this is a job? Do you try to analyze the current business situation and improve it from period to period? This shows that you’re running the business as a business–there is an intent to make a profit. Essentially, a business is defined as a venture that is taken on for profit. I have to admit–if you have been “in business” to lose money–the IRS (or any other taxing authority) will not view it as a business.
B.) The expertise of the taxpayer of his or her advisers
Are you a dog-lover? Do you really love old cars? How about starting a business working on old cars or starting a dog-training facility? Unfortunately, unless you have advisers helping you out or know about dogs or cars respectively, then there’s going to be a problem if you go into dog training or auto restoration. What you need to do is find someone who can help you determine what the best actions are to make your business profitable. Those advisers give credibility to the business that you might be lacking at first.
As I promised in “Do you have to suffer for your business?” and again in “Is your Business a Hobby? pt. 1” I’m going to explain what constitutes a business, based on the 9 tests that the IRS and the Tax Court has laid out to determine if a business is really a business.
A.) Manner in which the taxpayer carries on the activity
B.) The expertise of the taxpayer of his or her advisors continue reading this article »
IRS released guidelines to help taxpayers determine if their businesses were, in fact, hobbies. Why does this make a difference? Well, you can’t deduct the expenses for a hobby beyond the amount that you earned from the hobby. It’s incentive to make your hobbies break even. Here’s a link on how to determine for yourself if your business is a hobby. We’ll see Tax Court’s input tomorrow. (For that matter…the next few days.)
I was asked an interesting question the other day: “So once you have your CPA, you’re going to let the EA designation go?”
The short answer to this is, “No.”
Since we’ve started with the “vs.” theme in my “EA vs. CPA” post, let’s continue! We’ll go through a list of pros and cons for having an on-site bookkeeper compared to a remote or contract bookkeeper. There are a couple of things that need clarification. By onsite bookkeeper, I’m talking about a full or part-time bookkeeper who is a regular employee of your business. The remote or contract bookkeeper is a bookkeeper where you send your information and they prepare your books and give you the finished product (remote) or when the bookkeeper comes to your place of business on a regular basis and prepares your books (contract). continue reading this article »