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Is there any requirement that a business must be profitable…

Is there any requirement that...
Is there any requirement that a business must be profitable within how many years in order to file for business tax returns? So say if after 3, or 5 years the business is still not profitable, then you should no longer file business returns to get business deductions. State: California
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Answered in 10 minutes by:
3/28/2018
Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 33,360
Experience: Taxes, Immigration, Labor Relations
Verified

There is NO such requirement...

HOWEVER.

In general,

-- taxpayers may deduct ordinary and necessary expenses for conducting a trade or business.

-- an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit.

The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year.

If not - that doesn't mean that activity is not a business - but if the IRS will ever question that - you are expected to provide supporting documents regarding your reasonable expectation of earning a profit.

Questions?

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Customer reply replied 4 months ago
There is NO such requirement
- Hmm I got an audit and the auditor says I didn't make profit for the last 6 years while filing business returns, it is not a business, it is just a hobby and I shouldn't file business returns. Can I argue this auditor's point? Can you also point me to a tax law link that state there is no such requirement.If not - that doesn't mean that activity is not a business - but if the IRS will ever question that - you are expected to provide supporting documents regarding your reasonable expectation of earning a profit.
- What kind of supporting document? By "reasonable expectation", you mean like when I expect it to make profit?Thanks!

Can I argue this auditor's point? Can you also point me to a tax law link that state there is no such requirement.

If there is no such requirement - there is nothing we may point you...

Yes - you may argue with the auditor - and may appeal or may take your case to the court.

But regardless - you are expected to proof your reasonable expectation of earning a profit.

If your arguments will be accepted - you will be allowed to deduct losses.

- What kind of supporting document? By "reasonable expectation", you mean like when I expect it to make profit?

There is no specific requirements for documents.

Yes - that should be your reasonable expectation - basically - your intention

However - your intention would not be easier to proof.

Do IRS agent's arguments are that you run activities for many years and did not make any profit - we need to think what you may present to defend your position?

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Customer reply replied 4 months ago
basically - your intention
- So how do I put it in writting? Just plain English statement that I expect myself to make profit in 20xx year?IRS agent's arguments are that you run activities for many years and did not make any profit - we need to think what you may present to defend your position?
- Like what or how?

Just put you into the position of the judge

- there are two parties - you and the IRS agent

- the IRS agent tells that is not your business because you realized loss for many years - and there is nothing that may be viewed as profit expectations

- you are telling what? besides your words?

If you are not able to make your case - you will likely loose and the IRS prevails...

You know better your business and should have at least some arguments....

Can you compare with other businesses in your trade? in your area? Some examples ?
Do you have contracts ? Customer base than may be developed? Products that are selling ?

Business credit approvals? agreements with partners/investors?

Anything that may be considered as business plan?

I may not say that will work - but we need to have arguments to be judged.

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Customer reply replied 4 months ago
should I make these argument in writing?

Yes - and you may use ANY possible documents to support your position.

If the IRS agent will not accept your arguments and you choose to appeal - you might want a local CPA helping you to put all these arguments together and build your case.

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Customer reply replied 4 months ago
I heard there is something called auditor reconsideration. So I just make a call to IRS and set it up?Also I think I got some penalty because they think I made a mistake on the tax filing that made my return higher than it should be. Can you validate for me? I can open another question for this.

I will do my best but may not promise positive results.
.

Your first step will be to talk with the auditor and convince him or her to your position

If that doesn't work - you may ask to discuss your issue with the supervisor - but be prepared that will be a person with more advanced knowledge - so you may want to have a local CPA representing you.

You may try to challenge the auditor's position if your arguments were not considered.

If that doesn't work either - and you will get a final result after the audit is completed - you may appeal and ask for reconsideration.

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Customer reply replied 4 months ago
Your first step will be to talk with the auditor
- I already talked to him and he sent me a result. They gave me 90 days to appeal in Washington DC court. But I didn't respond right away so that 90 days has passed. But I recently called IRS and they told me auditor reconsideration is something different from the appeal and it doesn't matter that 90 days appeal has passed. Is it true?Let's say if I indeed made a mistake, how could a CPA help?

Yes - you may use the Audit Reconsideration when you disagree with the results of an IRS audit.

See second page here for details and steps

https://www.irs.gov/pub/irs-pdf/p3598.pdf

.

If there is a mistake - it should be corrected.

If that was a honest mistake - you might be able to ask for penalty abatement.

CPA may only help based on his/her experience and knowledge which you might not have.

But we should not expect any magic...

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Customer reply replied 4 months ago
Ok cool. But because they think I made a mistake, so the main point is not about to prove that I can make the business profitable. That is for if I file business return again and they question me, then I can present my expectation to make it profitable right?I will let you know if I have any followup questions. Also I will open a question probably tomorrow to see if I indeed made any mistakes.

Yes - correct - if the IRS disagrees with your classification of the activity as business - you may argue and provide your position.

It is possible when development takes many years before the product is ready for market.

Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 33,360
Experience: Taxes, Immigration, Labor Relations
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Customer reply replied 4 months ago
Ok thanks!
Customer reply replied 4 months ago
Ps I hope you don't mind me ask a very quick W-2 form question. On box 14 it says "CA SDI EE ( 201.28"Does it mean "CA SDI EE (" is the description while "201.28" is the amount?

That is for information only State Disability Insurance - yes that should be an amount.

See rates here - so you may verify

http://www.edd.ca.gov/Payroll_Taxes/Rates_and_Withholding.htm

The State Disability Insurance (SDI) withholding rate for 2018 is 1.00 percent. The taxable wage limit is $114,967 for each employee per calendar year. The maximum to withhold for each employee is $1,149.67.

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Customer reply replied 4 months ago
34;CA SDI EE (" is the description
- I wonder why there is a "(" in the description?

I though that might be a reference to the statute - but it is not

"(" might be a mistake...

or there could be a long description which was cut off.

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Customer reply replied 4 months ago
Cool thanks.
Customer reply replied 4 months ago
Hello I have a followup question -
Do IRS agent's arguments are that you run activities for many years and did not make any profit - we need to think what you may present to defend your position?
- Can I include this (that I will be able to make profit next year) along with my tax return filing? Since they will question why I put business expense in my tax return filing when my business is just a "hobby".

That is possible...

The IRS agent position - most likely - is that based on circumstances - it is not reasonable to expect any profit.

If there is no profit motive - that activity is a hobby.

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Customer reply replied 4 months ago
maybe just attached a page of my writing, mail it along with my tax filing to state my position, correct?

You definitely may do that - but whether the IRS will agree with your position or not - that is not guaranteed.

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Customer reply replied 4 months ago
Ok thanks!
Customer reply replied 4 months ago
Hi I opened a new question for you. Please check:
https://my-secure.justanswer.com/question/index/64d774090f03454a84a9545bab9adaf5?continueTheConversation=False&comingFromAdservEmail=False&ratedThroughEmail=False&rating=0&paymentType=Unknown
Customer reply replied 4 months ago
Sorry I think someone else took the question.
Customer reply replied 4 months ago
he has released the question. If you can let me know soon that would be great.
Customer reply replied 4 months ago
I just see this under publication 334:
Not-for-Profit Activities
If you do not carry on your business to make a profit, there
is a limit on the deductions you can take. You cannot use
a loss from the activity to offset other income. Activities
you do as a hobby, or mainly for sport or recreation, come
under this limit.
For details about not-for-profit activities, see chapter 1
in Pub. 535, Business Expenses. That chapter explains
how to determine whether your activity is carried on to
make a profit and how to figure the amount of loss you can
deduct.So I guess it is true you can't deduct if you are not carrying business to make a profit or in a business enough manner.

Yes - that is correct if the activity is NOT carried with a profit motive - that is NOT a business activity.

You still may deduct some expenses related to that activity - but only if that activity produced any taxable income - and may not deduct more than that income.

In other worlds - if that is a hobby - you may not use losses to offset other taxable income.

But if that is a business - you could.

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Customer reply replied 4 months ago
if that activity produced any taxable income
- But if the income is less than profit, can I still file business return and deduct it?
Customer reply replied 4 months ago
Ps could you please look into this question?:
https://my-secure.justanswer.com/question/index/4f7013204c2647e1b7826021e871c249?continueTheConversation=False&comingFromAdservEmail=False&ratedThroughEmail=False&rating=0&paymentType=Unknown
Customer reply replied 4 months ago
I mean income is less than expenses*

If that activity is NOT classified as a business - you may not report income and deduction as it were a business.

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Customer reply replied 4 months ago
I mean you sold merchandise (so it is a business), made some money but it is less than expenses (so no profit). So can you file business return?

If you determine that activity is a business - then - yes - you will report all transactions as such.

The key here is that determination.

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Customer reply replied 4 months ago
Ok thanks. So will you be able to answer my new question here:
https://my-secure.justanswer.com/question/index/4f7013204c2647e1b7826021e871c249?continueTheConversation=False&comingFromAdservEmail=False&ratedThroughEmail=False&rating=0&paymentType=Unknown

I will verify - but sorry for delay.

Ask Your Own Tax Question
Customer reply replied 4 months ago
No problem and thanks again!
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