One of the biggest benefits of a business is all of the tax write-offs you get. Often there are things that you have anyway, but once you have a business and you use them in the business, you’ve now gotten a deduction for them.
These kind of deductions will often put your business at a loss for tax purposes, even though you may be putting money in your pocket from the sales. That’s exactly what you want.
The IRS, though, may have another thought on the matter. If you have what they call a hobby, you cannot take that tax paper loss against other income. If you make money, you have to pay tax on it. But if you have a loss, there is no deduction.
The hobby loss designation is a bad thing.
There are 9 factors that the IRS looks at in making their determination, but those factors break down into 4 mail categories:
- Run your business in a business-like manner. Keep a separate bank account and credit card for the business. Use a business structure. Run your business LIKE a business.
- You have past business successes and if not, you have a coach, mentor, advisor or consultor who does. You are working on fixing what isn’t working and demonstrate that you know the importance of constant improvement.
- You are putting the necessary time and effort. This is especially true if you have a full time job. You can’t just start a business and ignore it, hoping everything will work out. At a minimum, the IRS wants to see you working 2 weeks a month and 3 evenings a week, if you’re working a full-time day job.
- You have profit, have had profit or will have profit. You need to show there is a business purpose to what you’re doing. This one can be a little trickier if your business has been having steady paper losses. But, it’s not insurmountable, just show that there is a light at the end of the tunnel and/or you are creating assets that contribute to your net worth. It’s possible to run paper losses for years and still be creating something of value. Amazon is a great example of that.
As you start your business, don’t forget you might need to prove it really is a business. It’s worth the time to do that.