By Leonard Holler, Wyoming Entrepreneur – Small Business Development Center Regional Director and Certified Public Accountant.
Brian from Torrington asks, “If my business is losing money will the IRS say that it is just a hobby and disallow my loss?”
The Internal Revenue Service looks at unprofitable businesses with a doubtful eye. The laws and regulations, however, do not provide a specific definition of what constitutes a trade or business because no single definition can apply to all cases. Generally, a trade or business must be an activity that is carried on with a profit motive and have economic activity conducted. The problem is that the "burden-of-proof" is the business owner's.
Here are some key factors the IRS considers in determining whether activities are engaged in for a profit. However, no one factor controls the decision by itself:
(1) The manner in which the taxpayer conducts his or her business activity is important. It must be done in a business-like manner similar to other profitable operations. One should maintain complete and accurate books. Budgets and financial forecasts are helpful. It is also helpful to belong to your industry's associations, attend educational seminars and subscribe to professional magazines and journals.
(2) The expertise of the business owner is important. Have you been trained in this business, studied the industry, or consulted with experts in the field? Have you sought advice from qualified advisors and then followed it? If not, have you documented the reasons why you did not?
(3) Time and effort spent toward your business is another key factor. Are you devoting enough time to the business activity? This does not mean you specifically if you have hired competent and qualified employees. If you left another job to spend more time on this business that may be evidence of a profit motive.
(4) Is there an expectation of asset appreciation? Anticipated asset appreciation must exceed anticipated losses for this to help your cause.
(5) Your success in other profitable business ventures is an indicator that future profitability may be achievable.
(6) Relying on profits from the business for personal living expenses is an indicator you operate a legitimate business. However, occasional small profits from a business generating substantial losses would be questioned.
(7) Do you have substantial income from other sources? If so, the IRS may question your profit motive. Any tax savings from your business activity is a factor against you.
(8) Elements of pleasure or recreation derived from your business activity may indicate you are not in it for profit. Actually the "lack of appeal", other than profit, will help significantly.
(9) Start-up losses that are present do not control the distinction either, but continued losses without any attempts to improve or correct your business might indicate you are not engaged in it for a profit. There must be a good faith objective and expectation of making a profit to have the business taxed as such. If your business is struggling -- seek advice, consider its effect on your business's profitability and if you think it will make your business more profitable, why not implement the changes. It will help support your argument that you are in BUSINESS and it is not just a HOBBY.