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Sunday, September 24, 2023

Tax Tips from a Local CPA

Scott County True Value Hardware Guns Ammo

By Anita Mize, CPA

Do you have a farm or business, or do you have a hobby?

Each year, many people want to start filing a business or farm on their taxes so they can write off losses.   On the other hand, some taxpayers don’t want to file a business or a hobby because they didn’t make any money.  Unfortunately, whether you make a profit, or not, doesn’t determine what you need to file for your taxes!  It’s important to understand what you have and how to report it for tax purposes.

A business or farm is defined as an activity that operates to make a profit.  You can’t just say you have a business or farm so you can write off all the expenses.  There must be an intent to make a profit.

A hobby is an activity you engage in for sport or recreation, not to make a profit.  Although this activity wasn’t started to make a profit, income earned from hobbies must be reported on your tax return.

So, here are the things to consider, to help you determine if you have a business, farm or just a hobby.

  1. Are you carrying out the activity in a businesslike manner – keeping complete and accurate books and records?
  2. Do you put in the time and effort needed to show that you intend to make a profit?
  3. Does this activity provide money to assist in your household living expenses?
  4. Are any losses in the startup phase typical of a business of this type or beyond your control?
  5. Do you adjust your operations to improve your profitability – make changes so you don’t continue to lose money?
  6. Do you have the knowledge to carry out this activity in a businesslike, profitable manner?
  7. Have you been successful and profitable in similar activities in the past?
  8. Did you have profit in some years or were all years losses?
  9. Do you have assets that will appreciate in value and result in profits in future years?

The general rule is that a business or farm must be entered into with plans to make a profit in future years.  The IRS wants to see a business profit within 5 years and a farm profit within 7 years.

My recommendations:

  • Have a written business plan that outlines your steps to grow the business and when you plan to make a profit.  Documentation is a key factor in convincing the IRS you have a legitimate business or farm.  Most businesses won’t make a profit in year one, but you should know when you plan to make a profit.
  • Keep good records – what did you do to get the business going, changes made to increase profitability, education you took to get more informed, clubs you joined to network with other similar business or farm owners.
  • Get organized – keep all receipts for expenses and records of income.  Even if you have a bank transaction for an expense – you still need the receipt for proof of what you purchased.
  • Be neat and organized so you have the information readily available to answer any questions that may arise during an audit.  
  • One bank account!  If you want to start a business or a farm – open a checking account for all expenses and income to run through.  One place for all income and expenses makes record keeping much easier than trying to track down expenses from multiple accounts or credit cards. 
  • Talk to a professional before starting the business.  Business entity (type of business structure) is very important so be sure you choose the correct one.

Good Luck to all you entrepreneurs out there!!   

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