Do You Really Have a Business?

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There are lots of definitions out there as to what makes a real business, but in this case, I’m talking about whether the IRS thinks you have a business. The answer might be more important than you know.

When it comes to profit and your business, one of three things is going to happen:

  1. You’re going to make money;
  2. You’re going to lose money; or
  3. You’re going to break even.

If you make money, the IRS will be happy to take your money. If that’s the case for your business, this chapter is going to be less significant for you.

If you break even, the IRS may want to make sure you really did take all of the business’s deductions correctly, but generally, they’re happy with that too.

But, if your business loses money, and you take that loss against other income on your tax return, the IRS is going to want to make sure you really do have a business. This chapter is for you.

If your business continually has a loss, the IRS may determine you don’t have a business. Instead, they will determine you have a hobby. Having a hobby business means that you pay tax if you make income, but if your business loses money, you can’t take that loss against other income.

So, if you have a loss for your business, be prepared to prove that it is a real business. This is especially true if you’re involved in something like dog breeding, horse training, sponsoring race cars, or even a network marketing company. Those are some of the industries that have abused the business loss rules in the past, and the IRS now looks closely at them.

If you have a loss, it’s up to you to prove you have a real business. Don’t assume the IRS is going to help you.

You might have heard that you need to show income for 3 out of 5 years for your business. This is just one test. If you pass this, the chances are good that you won’t have a problem with the IRS.

But, just because you have a loss for more years than that, don’t assume that you can’t pass the IRS test. After all, consider That company was started in 1995 and lost millions each year, before posting it’s first-ever profit in the 4th quarter of 2002. Yet the IRS never questioned those huge losses, year after year. Why?

Amazon was run like a business with a clearly defined profit-purpose.

There are actually nine factors that the IRS uses to determine if you have a business or not. If you have a business with a loss, make sure your tax preparer is up on the difference between a hobby and a business and has you prepped in case the IRS asks.

For more information on what it takes to prove to the IRS that you have a business, check out Chapter 4 in Smart Business, Stupid Business.

One Comment

  1. Clint says:

    Thanks for taking something that is somewhat fuzzy for even seasoned tax pros like us and making it easy to understand using the Amazon example.

    Bottom line is there are many so-called business out there that are actually hobbies and owners think they can get away with the write-offs year in and year out until the IRS catches them and they’re hit with not only the back taxes, but interest and penalties to boot.

    And speaking of Amazon, I’ve got a few books written by a certain CPA that I need to pick up 😉

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