Monthly Archives: October 2016

Know the IRS Tax Rules on Claiming Hobby Losses

Will you pay tax on a business or hobby?

By Silvia McClellan, CPA, Tax Department Senior Accountant

silvia-mcclellan-highres-6Are you launching a “side business”? Perhaps you hope to turn your love of writing or photography into a paying gig. Or maybe you’d like to sell some of that beer you’re brewing in the garage. If, like many start-up business owners, you’re operating at a loss, it’s critical to understand the IRS’s tax “hobby loss” rules.

Business losses are fully deductible, but hobby losses aren’t. Deductions for hobby expenses generally can’t exceed your gross receipts (if any) from the activity. Also, you must claim hobby losses as itemized deductions, which may further reduce their tax benefits.

What’s a hobby?
“Hobby” is a bit of a misnomer. You’ll find the rules in Internal Revenue Code Section 183, entitled “Activities not engaged in for profit.” The key to distinguishing between deductible and nondeductible losses is whether you engage in an activity with a profit motive. The IRS can’t read your mind, of course, so it analyzes objective factors, including the following, to decide whether an activity is engaged in for profit:

  • Whether you treat it like a business, keep accurate records and use those records to improve its performance,
  • your expertise and that of your advisors,
  • the time and effort you (or your employees) expend in carrying on the activity,
  • whether you expect to profit from the appreciation of assets used in the activity,
  • your success in carrying on other similar or dissimilar activities,
  • your history of income or loss with respect to the activity and whether its performance is improving at a reasonable rate, and
  • the amount of occasional profits, if any.

The IRS also considers whether you have other substantial sources of income from which you’re deducting losses (thus making it more likely the activity isn’t engaged in for profit) and elements of personal pleasure or recreation (the less enjoyable the activity, the more likely you have a profit motive).

No single factor determines the outcome. An activity is presumed to be for profit if it’s been profitable in at least three of the last five tax years (although the IRS can attempt to prove that it hasn’t been).

What if you incorporate?
There’s a common misconception that the hobby loss rules apply only to individuals. While the rules don’t apply to C corporations, operating an activity through a flow-through entity such as an S corporation, limited liability company or partnership won’t shield you from the hobby loss rules. In fact, doing so can lead to unexpected — and unwelcome — tax consequences.

Consider the recent case of Estate of Stuller v. U.S. The Stullers operated a horse-breeding farm through an S corporation. They owned the land used by the farm and received rental income from the S corporation. In a decision that was upheld on appeal, a federal district court ruled that the Stullers didn’t have a profit motive and, therefore, couldn’t deduct the S corporation’s substantial losses against their income from other sources. Even though the ruling meant that the Stullers received no tax benefit from the S corporation’s rental expenses, they were still required to report the rental income on their individual tax returns.

Treat it like a business
The best way to increase the chances that the IRS will treat an activity as a business is to conduct it in a businesslike manner. Create a business plan and budget, consult advisors and keep good records.  For sound business and tax advice for your business, contact Silvia McClellan, CPA, at Ciuni & Panichi, Inc., 216-831-7171 or smcclellan@cp-advisors.com.

You may also be interested in:

Save Tax Dollars and Fund Your Health Savings Account

Getting Comfortable with the Home Office Tax Deduction

© 2016

October Is National Financial Planning Month

Saving is a great start, but planning to reach your financial goals is even better.

Provided by Dane A. Wilson, Wealth Management Advisor

401(k) 403(b) audit SSAEAre you saving for retirement? Great. Are you planning for retirement? That is even better. Planning for your retirement and other long-range financial goals is an essential step – one that could make achieving those goals easier.

Saving without investing isn’t enough. Since interest rates are so low today, money in a typical savings account barely grows. It may not even grow enough to keep up with inflation, leaving the saver at a long-term financial disadvantage.

Very few Americans retire on savings alone. Rather, they invest some of their savings and retire mostly on the accumulated earnings those invested dollars generate over time.

Investing without planning usually isn’t enough. Most people invest with a general idea of building wealth, particularly for retirement. The problem is that too many of them invest without a plan. They are guessing how much money they will need once they leave work, and that guess may be way off. Some have no idea at all.

Growing and retaining wealth takes more than just investing. Along the way, you must plan to manage risk and defer or reduce taxes. A good financial plan – created with the assistance of an experienced financial professional – addresses those priorities while defining your investment approach. It changes over time, to reflect changes in your life and your financial objectives.

With a plan, you can set short-term and long-term goals and benchmarks. You can estimate the amount of money you will likely need to meet retirement, college, and health care expenses. You can plot a way to wind down your business or exit your career with confidence. You can also get a good look at your present financial situation – where you stand in terms of your assets and liabilities, the distance between where you are financially and where you would like to be.

Last year, a Gallup poll found that just 38% of investors had a written financial plan. Gallup asked those with no written financial strategy why they lacked one. The top two reasons? They just hadn’t taken the time (29%) or they simply hadn’t thought about it (27%).1

October is National Financial Planning Month – an ideal time to plan your financial future. The end of the year is approaching and a new one will soon begin, so this is the right time to think about what you have done in 2016 and what you could do in 2017. You might want to do something new; you may want to do some things differently. Your financial future is in your hands, so be proactive and plan.

Dane A. Wilson may be reached at 216-831-7171 or dwilson@cp-advisors.com
cp-advisors.com.

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
  
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Investment returns fluctuate and there is no assurance that a single rate of return will be sustained over an extended period of time. Investments are subject to market risks including the potential loss of principal invested
 
Citations.
1 – gallup.com/poll/184421/nonretired-investors-written-financial-plan.aspx [7/31/15]