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Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 29579
Experience:  Taxes, Immigration, Labor Relations
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I own a small business . My tax advisor tells me that after

Customer Question

I own a small business . My tax advisor tells me that after 3 years if the business is not making any money I cannot use any tax deductions. I am wanting to continue in business and try to get a tax return. Someone told me if I changed the name of the business I could start over. Is this true?
Submitted: 8 years ago.
Category: Tax
Expert:  Lev replied 8 years ago.

That is not exactly correct.

As long as you are in the business - all losses are deducted against your other taxable income regardless of how many years you had losses.

However - the IRS may question if that is a business activity - your activity is considered a business if it is carried on with the reasonable expectation of earning a profit.

 

An activity is presumed carried on for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses).

If your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity.

 

If you are not sure whether you are running a business or simply enjoying a hobby, here are some of the factors you should consider:

  • Does the time and effort put into the activity indicate an intention to make a profit?
  • Do you depend on income from the activity?
  • If there are losses, are they due to circumstances beyond your control or did they occur in he start-up phase of the business?
  • Have you changed methods of operation to improve profitability.
  • Do you have the knowledge needed to carry on the activity as a successful business?
  • Have you made a profit in similar activities in the past?
  • Does the activity make a profit in some years?
  • Do you expect to make a profit in the future from the appreciation of assets used in the activity?

So the main question would be if that is a business or hobby activity. Hobbies, also called not-for-profit activities, are those activities that are not pursued for profit.

 

Lev and other Tax Specialists are ready to help you
Customer: replied 8 years ago.

 

 

Dear Sir or Madam,

 

When you say "

If your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity. Does this mean I cannot take advantage of the tax deductions for 2008. I can carry on for the year 2009 and then we will see what happens.?

 

 

Thank you Cindy Lynn

 

Expert:  Lev replied 8 years ago.

The main issue is to classify your activity as a business or as a hobby.

  • If that is a hobby - activity is not carried on for profit - your deductions are limited by the gross receipts for the activity.
  • If that is a business - it is carried on with the reasonable expectation of earning a profit. - there is no limitation for deducting qualified business expenses.

As your expectation is hard to determine - the IRS is using a simple test - an activity is presumed carried on for profit if it makes a profit in at least three of the last five tax years. If you reported losses two or three consequences years - the IRS might disagree to classify the activity as a business unless you would provide other supporting evidences.

Please be aware that is the IRS disagrees - you likely will be disallowed deduction from the beginning of the activity.

If you simply carry the same activity under different business name - that might be considered as tax evasion - and would not help you.

 

If your intension is eventually to make a profit - you need to provide evidences about the reasonable expectation of earning a profit.

 

Customer: replied 8 years ago.

Sir or Madam,

What would be an" example of evidence to the IRS to turn my hobby into a business". I have rented space at $1400.00 per month my Internet and office phone comes to $125.00 a month and my Sprint bill is $250.00 a month and inventory is $5000.00, and miscellaneous expenses $1500.00. What amount would be factored in to show profit. This is to indicate how serious I am to keep the business, knowing one day I will have a break through.

 

Thank you

Cindy Lynn

Expert:  Lev replied 8 years ago.

"wanting to turn this into a business" - means that you are running the activity as a hobby and thinking to turn it into the business some time later - that is not a position to deduct business losses.

To deduct business losses - the activity should be carried on with the carried on with the reasonable expectation of earning a profit.

 

A hobby is an activity that is not pursued for profit. If - for instance - you have a profit - you had better have a profit from a hobby - because it is not subject of self-employment tax.

 

You profit motive should be very clear when the activity is started.

Some examples.

1. assuming you wrote a book - you spent three years working on the text and on more year trying to publish it - that sounds as you had a profit motive and have the reasonable expectation of earning a profit.

2. you are running a "manufacturing plant" in your spare room - you spent two years working on your invention - got a patent protection - and are selling a product - but so far was not very successful and three years on the row had losses - while it is hard to predict - that also sounds as you had a profit motive and have the reasonable expectation of earning a profit.