by April Thiel, CPA, Senior Manager at Gordon Advisors, P.C.
Many small businesses are organized as a sole proprietorship and file a Schedule C on the owner’s personal 1040. What happens when your expenses exceed your income and you incur losses? Can you still claim those tax deductions? The answer is; you can deduct them if you can show that you are truly running a business and not merely engaging in a hobby.
Taxpayers are allowed to deduct ordinary and necessary business expenses. In order for the IRS allow the deduction as a business expense, you need to make sure the activity or business is considered “engaged in for profit”. You need to make a profit in at least three of the last five tax years in order for your business to be considered for profit and not merely a hobby. In addition to that requirement, here are a few (not all inclusive) factors to consider:
Do you depend on the income from the activity?
Do you conduct business in a professional way? (A website, business cards, letterhead, etc.)
Does the time and effort you put into the activity indicate your intention of this being a business?
Do you expect to make a profit?
Do you have the necessary knowledge to be successful in the business?
Do you treat it as a business?
The IRS is trying to ensure that you are not merely turning what is a hobby, into a deductible loss. Here are a few ways you can help substantiate your legitimate business expenses: keeping good records, hiring some professionals, write a business plan, keep business and personal expenses separate & ensure your income and expenses are matched properly. The IRS scrutinizes this area intensely and will audit and disallow your expenses if they believe you are not truly in business. Contact a Gordon Advisors tax advisor today to discuss.