Tax Tips: Is it a hobby or a business?
Filed under: Tax
You've started a little enterprise in your garage or spare bedroom. And now it's tax time and you're ready to reduce your taxes by taking a whole bunch of deductions for this "business." Stop right there. You might not be entitled to take those deductions, and if you do, you may be asking for trouble.Here's the key: Deductions for small businesses are only allowed to be taken when the venture is an actual business. A pyramid scheme is not a business. A "gifting club" is not a business. Making crafts and giving them away is not a business. You get the idea. The rules are fairly straightforward. Directly from the IRS website are the most pertinent points:
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Does the time and effort put into the activity indicate an intention to make a profit?
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Does the taxpayer depend on income from the activity?
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Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
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Has the taxpayer made a profit in similar activities in the past?
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Does the activity make a profit in some years?
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Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
In general, you must turn a profit in at least three of the five last tax years in order for the IRS to consider your "business" a profit-making activity.
One very common issue with business losses relates to a taxpayer's participation in a multi-level marketing company. Research has shown that more than 90% of people lose money in these ventures, so I think that future of the IRS allowing deductions for these ventures is in question. Be very careful when your recruiter touts the "tax advantages" to getting involved in their scheme.
Tracy L. Coenen, CPA, MBA, CFE performs fraud examinations and financial investigations for her company Sequence Inc. Forensic Accounting, and is the author of Essentials of Corporate Fraud.
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Reader Comments (Page 1 of 1)
4-09-2008 @ 6:55PM
al coholic said...
Question...
My wife recently started a horse boarding facility. It has been set up as a LLC. This is a real business, though she has no illusions about making a lot of money doing it. Does the three out of five year rule apply to her?
I promise not to bring up your "perspective"...LOL
Al
Reply
4-14-2008 @ 12:13AM
JRosen said...
wow, you truly are nuts aren't you? You can't even write an article without talking about your obsession with hating MLM companies. There's absolutely NO way the IRS is going to not allow a deduction from a valid MLM distributorship. Don't be misleading Ms. Coenen, you're CPA doesn't make you a tax expert or better insight into what the IRS is thinking. Unless you have facts and support, don't make stuff up.
Reply
4-14-2008 @ 10:05AM
Tracy Coenen said...
Spoken like a true MLM cult member! One of the requirements for taking a BUSINESS deduction is that there has to be an expectation of profit. Almost no one in MLMs makes a profit, so there really isn't that expectation. I cannot wait for the day that the IRS decides to enforce this rule.