As you attempt to start and grow a business, you may find that it is difficult at first to earn a profit. While this financial floundering can create various personal problems, it can also cause an issue with the IRS. This is because the IRS may try to qualify your business as a hobby, which can create significant tax problems.
When a small business does not earn a profit, especially for multiple years in a row, there is a risk that the IRS will deem the business a hobby rather than a business. The IRS will make the assumption that the intent of you, the business owner, was to never earn a profit in the first place. This classification spell bad news because if your business is deemed a hobby, then deductions for business expenses are not allowed. Deductions are only permitted if they’re incurred in the process of earning income.
Proving Your Business’s Legitimacy & Deducting Expenses
If your business has been wrongfully classified as a hobby, what can you do? If your business hasn’t earned a profit in 3 of 5 consecutive years, the burden of proof will fall on you to prove your intent to earn income. This good-faith demonstration can be achieved in a variety way ways, but it typically involves demonstrating the objective steps you took in an attempt to earn income. Start gathering any documentation you have pertaining to:
- Advertising or other marketing materials,
- The implementation of a specific business development plan or promotional plan,
- Cutting expenses,
- As well as attending seminars or other continuing education opportunities.
These examples are just a few of the ways you can prove your business’s legitimacy; you may have other evidence available to you that will help your case even more. If the IRS is challenging your tax deductions, our tax attorneys can help your prepare a response. It is important to act quickly! Contact us today at 800-721-7054 for a free consultation!