iS YOuR BuSinESS A HOBBY? dO nOT LET THE iRS dECidE
Tax law Section Chairs: Brian Harris- Akerman LLP & Christopher Dingman- Barnett, Bolt, Kirkwood, Long & Koche, P. A.
Each year, many“ snowbirds” pack up their lives and take their talents to Florida. While in Florida, many of these taxpayers decide to pursue a more entrepreneurial endeavor( in stark contrast to their steady paycheck back home). That accountant in Philadelphia may make a phenomenal snow cone, and the data processer in Chicago may have always dreamed of selling his one-of-a-kind Polish sausage recipe to the masses. Why not turn these pursuits into full-time businesses?
While any taxpayer is welcome to use their hard-earned money to start a new venture, not all businesses are treated equally from a tax perspective. Ordinarily, the IRS allows a deduction for all ordinary and necessary expenses paid or incurred by a taxpayer in carrying on a trade or business, and to the extent these expenses exceed the income in a given year, the resulting loss can be used to offset other sources of income in current, previous, or future years. Despite this general rule, deductions related to activities that do not have a profit motive( in the eyes of the Internal Revenue Service) are limited to income from that activity.
Whether an activity has a profit motive depends on whether the facts and circumstances indicate that
© Can Stock Photo / EMarket the taxpayer entered into or continued the activity with the intent to make a profit. In examining a taxpayer’ s intent, the IRS looks to“ objective standards, taking into account all the facts and circumstances of each case” to determine whether the taxpayer engaged in the activity with a profit motive. To avoid a“ hobby” classification, the facts and circumstances must indicate that the owner entered into the activity or continued the activity with the objective of making a profit; however, a reasonable expectation of profit is not required.
To aid in determining whether a profit motive is present, regulations promulgated by the IRS identify nine objective factors( none individually determinative) to aid in supporting that an activity is engaged in for profit:( 1) the extent to which the taxpayer carries on the activity in a businesslike manner;( 2) the taxpayer’ s expertise or reliance on the advice of experts;( 3) the time and effort the taxpayer expends in carrying on the activity;
whether an activity has a profit motive depends upon whether the facts and circumstances indicate that the taxpayer entered into or continued the activity with the intent to make a profit.
( 4) the expectation that the assets used in the activity may appreciate in value;( 5) the taxpayer’ s history of income or loss from the activity;( 7) the amount of occasional profits, if any;( 8) the taxpayer’ s financial status; and( 9) the elements of personal pleasure or recreation. Of course, the best way to avoid a fact-intensive discussion( and to create a presumption that profit motive exists) is to produce a taxable profit from the activity for two or more taxable years in a period of five consecutive years. Many businesses go through growing pains in their early years. Therefore, to avoid the potential loss disallowances, any new owner should consider the factors listed above( regardless of the individual’ s lofty expectations for future profitability).
Author: Matthew E. Livesay- Barnett, Bolt, Kirkwood, Long & Koche
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