With So Many Entrepreneurs Starting Businesses, Don’t Let Your Become a Hobby!
I hope you have managed to stay safe and well! We focus on resolving tax issues in Prince William County and throughout the lower Northern Virginia area.
Now, that you decided to enter the arena that is Entrepreneurship, be sure to keep your endeavor looking like an actual business. The very essence of being in business is to make a profit. Now, its definitely true that the majority of businesses fail within the first five years of their existence, and even more significant percentage fail to “turn” a profit for their first few years of existence. So, there are a number of people out there that operate on the premise that their business can claim five straight years of Net Operating Losses (NOLs), and be in full compliance with the IRS.
It's important to know that the IRS only allows NOLs for two out of the last five years that a business is in operation. And if that business has NOLs for more years than referenced, your business must be able to pass nine separate factors to determine whether or not you’re actually engaged in a hobby (Hobby Losses can only be deducted to the extent of Hobby Income). Now, you may be under the impression that this is no big deal, but a redressing of your business could quite possibly lead to significant shifts in your Adjusted Gross Income (AGI), which impacts everything from deductions and credits to tax rates from the tax table.
The Nine factors for a determination between a Hobby and an Actual Business Venture are:
- How “you” the taxpayer conducts the activity- are you doing so in a business-like manner (business bank account, books and records, acting like other profitable entities)
- Your expertise in the activity- significant expertise and have sought expert advice
- Your time spent conducting the activity- is the majority of your time spent on the activity and making it profitable
- Your expectation that assets within the business will appreciate in value- appreciation may be a substitute for profits
- Your success in other activities- have you been able to change the fortunes of other ventures from unprofitable to profitable
- Your history of income/loss from the activity- have you had sustained losses (Questionable) or any sustained profits, and the downturn is economy based
- The relative amount of the profits and losses- meaning the amount of losses in relation to the amount of your profits
- Your financial status- are you relying on the revenue (and ultimately profits) from the business for your standard of living
- Are you receiving recreation or “pure” enjoyment from engaging in the activity- is there a recreational aspect to your activity, that would prompt you to engage regardless of profit
Seasoned Tax Professionals who understand how spot these signs can conduct their clients along safe routes and advise clients about how to avoid hobby rules and navigate taxpayers through an audit or any questions the IRS may have. We would be happy to help you with your representation needs. Please feel free to contact us