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socrateaser, Attorney
Category: Business Law
Satisfied Customers: 38913
Experience:  Retired (mostly)
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Hi again, When filing on a schedule C, if you have a loss

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Hi again,
When filing on a schedule C, if you have a loss the first two years and then again on the third year, will the IRS consider you a hobby for the first two years? I'm still going through my paperwork. Just kind of worried I owe back taxes. This ebay business is becoming a huge headache. I honestly was trying to make money.

The IRS takes the position that an activity is presumed/considered "for profit" if it is profitable at least three years out of every five. If you file three tax returns showing that you have three years of losses, the IRS will send a letter asking you to waive the statute of limitations for its determination that your business is "for profit." If you agree, then you will be allowed to continue for another year, before the IRS decides whether or not to audit you. If you refuse, then you may be audited immediately, in which case, your deductions to the extent that they exceed your revenue may be dissallowed.

So, even if you make $1.00, you are better off than you would be were you to report three consecutive Schedule C losses. You may want to consider limiting your deductions to the amount of your revenue, so that you can show a small profit, and avoid the almost certain audit letter that would occur.

Please let me know if my answer is helpful or if I can provide further clarification or assistance.

And, thanks for using!
Customer: replied 3 years ago.

ok, because I claimed a profit the second year, but just realized I forgot to include my shipping costs. So, not claiming all your deductions is fine. I am not trying to claim losses. I'm trying to close up shop, because it really isn't worth my time. I know they have that rule because people got stupid and claimed everything under the sun. If I'm in doubt, I never claim it. I'd rather over pay my taxes, than underpay. I'm an extremely honest person and if I thought I owed, I'd show up on their doorstep and let them know. I guess they are trying to stop the people who are trying to push the limit.

There is no law prohibiting you from claiming fewer deductions. The law prohibits failing to report income. As long as you're reporting your income and not manufacturing deductions from thin air, then you are not at any risk.

And, if you claimed a profit in the second year, then you are not a likely audit risk. So, from what you described, you appear to be in pretty good shape.

Hope this helps.
Customer: replied 3 years ago.

Thank you, XXXXX XXXXX auditing all my records right now. I noticed that a $38 check I had for last year was logged in for this year. I should refile my taxes then, even if it doesn't change the amount I owe, because I didn't include my shipping.


You certainly can file an amended return (1040X). I don't know that it's worth it for $38. An auditor would probably ignore an error of that amount, if it were the only error. Even the IRS phone representatives can waive $150 in taxes at their discretion. So, $38 in income is nothing.

Choice is yours.
Customer: replied 3 years ago.

So anything up to $150 is ok. I just don't want to go to jail. Like I said, I'm still going through everything for the last few years. I know I don't owe them anything, because of the deductions I left out. If you get audited, do they let you present other deductions?

Anything up to $150 in taxes is usually avoidable. That could be $1,350 or more in incorrect deductions, dependent upon your tax bracket.

Re jail, that's not going to happen. It would cost the USA 1,000 times what you might owe to prosecute you for criminal tax evasion.

Re other deductions, you can amend your tax return while an audit is taking place. The auditor would have to stop and wait to review your amended return. So, "yes," you can present other deductions. What I have done is to present the deductions, tell the auditor that, "My client has found the following additional deductions. If we can settle this here without filing an amended return, great -- otherwise, we will amend the return, and that will render this audit moot."

Hope this helps.
Customer: replied 3 years ago.

I think I'm just a little overwhelmed right now. I'm going through every auction, inventory item,piece of paperwork ect. for the last few years. We moved twice during my business and had to have emergency repairs on our home. Add to that two kids ect. Maybe I'll take a week or so away from it. I'm such a worry wort.

I understand your concern. I hope I have been able to help you better understand the law, so that you can make an informed decision.

Best of luck with all of this!
socrateaser and other Business Law Specialists are ready to help you
Customer: replied 3 years ago.

Thank you so much. You have put me at ease. Like I said, I'm probably too honest for my own good. I really appreciate all your time. You are wonderful. I think my biggest worry was that they were going to hunt for additional deductions if I got audited. I really can't afford to loose all that inventory if I was to be considered a hobby.

I got it. Please consider asking for me in the future, if you have further questions.
Customer: replied 3 years ago.

Ok, one more question. Most of my items sold were bought retail and I paid sales tax on them. I didn't include the sales tax I paid for the items I bought in California in the cost of goods. The reason I didn't do this is because, California had me fill out 1 form for sales and use tax. So essentially, the sales tax I paid would offset any use tax I owed. We moved from California, so obviously I'm not paying use tax to California. I had inventory left over from California. For the items that I sold that were not offset by use tax, can I add the sales tax in? Or will it just mess everything up.

You should have included the tax in your Schedule C gross receipts, and the subtracted it out on Line 23. If you did neither, then the net result would be the same, so it would be silly to do it now.

Hope this helps.
Customer: replied 3 years ago.

I think you misunderstood. Example: Say, I bought an item for $5 and paid 40 cents sales tax. I recorded in my cost of goods sold that it cost me $5 not $5.4, because I knew I'd get it back when I filed my sales/use tax. I thought it would be dishonest to include it. Well , After I moved, wasn't being charged use tax for obvious reasons. Can I add the 40 cents into my cost of goods sold.

I'm not following the logic of your reporting method. I can tell you what you should have been doing:

1. All of your gross receipts, including sales tax, must be reported on Schedule C, Line 1. Using your example, this would be $5.40.

2. Your total sales tax collected and remitted to the government, must be reported on Line 23. Using your example, this would be $0.40.

If you reported in some other manner, then you need to amend your Schedule C.

Note: I've answered, in good faith, a lot of additional questions here. I would appreciate it greatly if you would provide me with another positive rating for one of my answers, so that I can receive appropriate compensation for my additional efforts.

Thanks again for your continued confidence.

socrateaser and other Business Law Specialists are ready to help you
Customer: replied 3 years ago.

No problem. Thank you.

Customer: replied 3 years ago.

I really do appreciate your time. You have been wonderful. I went ahead and sent another payment. Please forgive my ignorance. To explain the entire sales/use tax thing. I'll try to explain this better. When you fill out the CA form, you add the sales tax owed plus use tax on any personal items withdrawn for personal use or any personal items you bought without paying sales tax. The way the form is set up you have to do it this way. Then you subtract the sales tax already paid from your purchases. So if I owe $20 sales tax and $20 use tax and then subtract $40 in sales tax already paid, I would owe $0 to the state for sales and use tax. So what I'm saying is that if I claimed that $20 in sales tax that offset my personal use tax, I would be lying, because they gave it back to me.

You seem to have shifted into a conversation about the California BOE sales tax remittance form (BOE-401-A2). This has nothing to do with federal income tax reporting on Form 1040, Sched. C, which is what we've been discussing throughout this Q&A session.

With respect to the BOE form, if you really want to discuss it, I think it would be better to open a new Q&A session, so that we're not confusing this with your federal income tax obligation reported on Form 1040, Schedule C.

You can put my userid at the beginning of your new Q&A session, if you want me to answer.

Thanks in advance.