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Lev
Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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Id like to start a business that will show a paper loss

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I'd like to start a business that will show a 'paper loss' in 2011. I'll be receiving a lump sum payment when I leave my current employment, and I'll have about a $100k tax liability. The lump sum is non-qualified (deferred salary). So I'm not looking to make a profit, just looking to defer taxes on a lump sum amount. Any ideas?
Submitted: 3 years ago.
Category: Tax
Expert:  Lev replied 3 years ago.

LEV :

Several issues…


First of all – to deduct your business expenses – your business should already been started. In most situations – that means you have received business income. Sometimes your business might be treated as started even you have no sales, but had a product for sale – for instance - real estate agents have clients and advertised properties – even there is no any closed contracts and no payments. Manufacturing businesses may be considered as started – when a manufacturing process is started even if there are no sales. Thus – in case of audit – you should be able to proof that your business has been started in 2011 – otherwise the risk is that your deduction would be disallowed.


 


Secondary – according to the IRS, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit. As you wrote “I'm not looking to make a profit,” – the risk is that your activity will be treated as a hobby and not as a business – and you would be disallowed to deduct losses.


 


Further…


You may deduct ordinary and necessary expenses for conducting a trade or business. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is appropriate for the business. That means – in case of an audit – you should be able to proof that all expenses you deduct are ordinary and necessary.


 


If you purchase a diamond – you may not deduct the cost until you sell it. When you sell it – your gain/loss is a difference between purchase and sale prices. Also – if you have a loss from the sale of a capital asset – you are allowed to deduct only up to $3000 in the year of sale (unless you have other capital gains) and the rest will be carried over to following years.


 


While your intention is clear and understandable – having a “paper business loss” bears a risk of audit – I would not recommend that way – unless you are looking for a “real business” which might generate losses in years. Generally – as long as your activity generate losses three out of five years – the risk is that the IRS will be treated it as a hobby and not as a business.


Let me know if you need any help.


 

Customer :

Thanks, XXXXX XXXXX the prompt response.

Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22844
Experience: Taxes, Immigration, Labor Relations
Lev and 10 other Tax Specialists are ready to help you
Customer: replied 3 years ago.

Hello LEV, I've already accepted your reply but I thought of something else.

 

So what, if anything, can be done to defer taxes on the lump-sum? If I start a business, for instance, to sell a widget on eBay, and I'm selling the widget during 2011, and before the end of the year, I buy a bunch of 'widgets' to have in inventory, does that qualify as a ordinary business expense?

 

I'll be 'retiring', so I'll be looking to do something to generate a bit of income.

 

Thanks again, LEV.

 

Don't know if it's ok to send you my email... Its the first time I use this site.

 

It is edlmontero at h o t ma i l . If it's not OK to send, just ignore it.

 

Regards,

 

Ed

Expert:  Lev replied 3 years ago.

Hi Ed,

Appreciate you for accepting the answer.

Most individuals and many small businesses use the cash method of accounting. Generally, if you produce, purchase, or sell merchandise, you must keep an inventory and use an accrual method for sales and purchases of merchandise.

An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. If you must account for an inventory in your business with some exemptions - you must use an accrual method of accounting for your purchases and sales.

To figure taxable income, you must value your inventory at the beginning and end of each tax year. - see IRS publication for more details - www.irs.gov/pub/irs-pdf/p538.pdf

Unfortunately purchase of inventory would not be deducted as business expenses unless it is sold. Please take a look at the schedule C - http://www.irs.gov/pub/irs-pdf/f1040sc.pdf part III. As most of your inventory will not be sold - that will be carried over to the following year and not deducted.

 

According to Just Answer rules - I may not communicate with customers outside this site.

 

Based on information provided - and considering issues mentioned above - you might be able to generate a small loss if you purchase business properties (not inventory) - for instance computer to track your sales and deduct a total cost using section 179 instead of depreciating the property over its useful life.

 

Let me know if you need any help.

 

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