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Columns by June Walker: IPs Face Unique Tax Challenges Tax Deductions Are There For The Taking You Say You're Self-Employed -- Will the IRS? Criteria for Self-Employment Do You Have a Business or a Hobby? Proving That You're a Business Keeping Records -- It's Not Just for Taxes Three Ways to Expand Your Business Deductions Can I Deduct Disneyland and Other Questions Mixing Business with Pleasure and Other Gray Areas Quicken for IPs Courses That Qualify Training You Can't Deduct Getting There is Half the Battle Taking Deductions on the Road Getting Credit and Taking Allowances Advertising: Do It, Then Deduct It The Subtle Art of Advertising Deductions Billy Bridesnapper's Start-up Saga Starting Up and Shutting Down Start-Up Wrap-Up Giving Gifts, Taking Deductions

Proving That You're a Business Why would you want to prove to the IRS that you're in business, even though it's unprofitable? For one thing, if you're an individual, being "a business" may entitle you to deduct your business losses from other (unrelated) income. However, if what you're doing is just "a hobby," you can only deduct losses up to the amount of money the hobby itself generated. How do you prove to the IRS that you're running a business, even though you're not making any money? A number of books advise entrepreneurs to just "show a profit." That's like telling Mick Musician to make the charts with a hit song three years out of five... or, if that doesn't happen, he should forget about a lot of his expenses, pretend he made a profit, and pay Uncle Sam more than is his due. Pretty dumb advice. But, if you know that your self-employed business is going to make you rich (someday) even though you've had a loss every year since you started your new venture, how do you prove to the IRS that your goal is to make a profit? The IRS says that if you treat your activity like a business, then a profit motive is indicated. The IRS lists nine guidelines to help you determine if you're treating your activity like a business -- and thereby in it for the money. No one item on the list is the determining factor, nor is this a complete list used by the IRS in making a decision, but these are the criteria normally taken into account: If it walks like a business and talks like a business, it must be a business. 1. Carry on the activity in a businesslike manner Are your books and records kept completely and accurately? Is your activity carried on like similar businesses which operate at a profit? If methods you used proved unprofitable, did you change your methods or adopt new techniques in an attempt to improve profitability? 2. Expertise of the taxpayer or his advisors Have you prepared to enter this business by studying the accepted managerial and technological practices of those already in the field? Are your business practices similar to others in your profession? If not, are you attempting to develop new or superior techniques which may result in future profits? 3. Time and effort expended Do you put more time into marketing your business than you put into fly fishing? Do you employ someone with the expertise you may not have or who puts in the time you are not able to? Did you leave another job to devote more time to this activity? 4. Expectation that assets used In the activity may appreciate in value The term "profit" includes appreciation of assets. Will the land, equipment, or instruments used in your endeavor increase in value, so that your future profit may be realized not only from income, but also, perhaps, from the appreciation of these assets? 5. Success in carrying on similar or dissimilar activities Have you taken a similar activity and converted it from an unprofitable to a profitable enterprise? Have you had general success in running other kinds of businesses? 6. History of income or losses with respect to the activity Losses early in the history of a business are common. Are your losses due to start-up costs, or have they extended beyond the normal time for this kind of activity to begin making a profit? 7. Amount of occasional profits There may be a disparity between the amount of profits that you make, relative to the losses you incur or the amount of money you spend on assets used in your activity. For example, the purchase of a $3000 camera, without a single sale of a photograph, may tell the IRS that your photography is really a hobby. However, can you justify this by showing that you have an opportunity to make a substantial ultimate profit in a highly speculative activity? A writer may work on a book for years before it is published. Perhaps you can show that your business is the type that will have an occasional large profit but small operating losses over many years. Be careful of the next two: 8. Financial status of the taxpayer If this is your only source of income, then you must be in it to make a profit. If, on the other hand, you've got large income from other sources, and the activity in question generates substantial tax benefits, this could indicate to the IRS that the activity is not carried on for profit but as a home-made tax shelter. 9. Elements of personal pleasure or recreation The IRS says "elements of personal pleasure or recreation" may indicate the lack of a profit motive. So don't enjoy your work too much! The story of Stella Waltzkin is an interesting example of IRS thinking. This actual case shows that you certainly can be engaged in a business even if it has always operated in the red. Stella, an artist, supported herself for some years by selling her art, teaching art, and designing fixtures for a lighting company. After receiving an inheritance, she no longer had to depend on the sale of her art, but continued at it anyway. During the ten-year period after getting her inheritance, Ms. Waltzkin continued to lose money on the sale of art. One year she claimed a $40,000 loss on $6,000 of income. The IRS ruled her activity a hobby. But the federal courts overruled the decision. "It is well recognized," the court noted, "that profits may not be immediately forthcoming in the creative field and many artists have to struggle throughout their careers. This does not mean that serious artists do not intend to profit from their activities. It only means that their lot is a difficult one." Whether you're a self-employed artist or one of the other 25 million self-employed people now boppin' around the USA, you can make your lot less difficult by understanding how the IRS looks at taxes for the self-employed, and by doing your best to meet the agency's criteria. So keep in mind the main points of what I've covered in this series: Just because you are paid as a self-employed person does not mean you are self-employed. There are specific factors that determine whether you're an employee or self-employed. For the IRS to treat you as an independent contractor, being self-employed is only part of the picture; you must also be able to prove that you're in it for the money -- that you're running a business. The best way to do that is to keep complete and accurate records. Some people complain, and rightly, that the IRS intrudes into their businesses by forcing them to keep various kinds of records. But there is a more positive way to look at it. IRS regulations compel you to treat your endeavor in a totally serious manner, and that can work to your business and tax advantage.   (c) 2000 June Walker. All rights reserved. We'd love to hear your feedback about this column, or put you in touch with June Walker if you like. You may also like to see her biography.