The first thing to do is to determine why it is that your accountant wanted to get rid of you.  For this, there are two options: Either it’s you or it’s not you.

Is it YOU?

Do you complain about your bill?  Are you constantly asking for changes to your accounting or taxes once you have them?  Do you give your accountant really short deadlines?  Are you just rude?  There was one client we had in particular that wold only give us half the information necessary to complete their return and once they had filed the tax return, they came back with additional info and asked to have the return amended.  It happened three years in a row.  Inevitably, they came back to us and asked why the bill was so high!  We prepared two returns for them–the original and the amended–that’s why!  That’s really being unreasonable.

No, it’s not you.

Sometimes, accountants just want to downsize–they don’t want as many clients as they currently have.  If you’ve just started with an accountant and find yourself being fired within a year, they might not want to have such a big client base and cut out the newer clients in order to preserve the loyalty they have to the older clients.  Another option is that you accountant is up-scaling.  I saw this at each CPA firm I’ve been with–they instituted a minimum annual billing and anyone falling below the fee had to find somewhere else to go.  With one firm, it was a minimum of $250, with another it was a minimum $1,000.  Accounting practices do change, too, and alter their focus.  Several practices I know have decided to drop a key service they provided in order to focus on more lucrative or less restrictive services.  I have to say, being fired for not meeting the minimum is a lot nicer because it means that they didn’t want to hike your bill to meet the new fee floor.

If you’re on good terms with an accountant–ask them about clients they’ve fired.  We all have a few stories to tell.

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.

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.

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.

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.

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.

In each of the next 5 parts, we’ll cover each of these elements in depth. More tomorrow…and the next day….and next day….you get the picture.

So close! This is really frustrating since I got a 74 the last time around on BEC. (I know, TWO 74s!) I passed the tax section, REG, over a year ago with no studying. What does this tell me? The obvious–I should stick with what I like and focus on taxes!