JACKSON TOWNSHIP, NJ - It's all about the “Pursuit of Profit” for the IRS to consider your Business a Business. So, how was business this year? Did

JACKSON TOWNSHIP, NJ - It's all about the “Pursuit of Profit” for the IRS to consider your Business a Business.

So, how was business this year? Did you make a profit? If your business is very new, most likely you took a loss. Oh well, at least you can write it off, right?
Well... maybe.
Whether you can write off your business losses depends on whether your business really is a business or a hobby.
"Of course it's a business!", I hear you say. "I don't put myself through this for the fun of it!"
That's what Brenda Konchar thought.
Brenda Konchar, a Mary Kay Cosmetics representative and Indiana mother of 4, reported her Mary Kay activity as business income.
The IRS disagreed. Konchar took her case to the Tax Court...
... and lost. (See: Konchar and Konchar v. Commissioner of Internal Revenue, (Docket 5388-01S-2004)
So what does it mean?
In a nutshell, if you earn income in the pursuit of a hobby, you can offset the income with deductions. You cannot claim deductions that exceed your income – there’s no loss for a hobby.

However, if you earn income in the pursuit of a business, you can not only offset the income with deductions, you can carry any losses forward. This can be huge for new businesses.

Brenda Konchar had deductions which exceeded her income and reported net business losses for the years 1996 through 1998. The IRS disallowed the losses, claiming that Konchar’s activities constituted a hobby. As a backup, the IRS claimed that even if she were operating a business, her expenses were not properly business expenses.

Here's the important part: The IRS consider a number of factors when determining whether a taxpayer is engaging in a business or a hobby, none more important than profit motive.

The IRS considers that you are engaging in a business when it is your intention to make money. You should be able to demonstrate that you have made a profit for at least three of the last five tax years.

Of course, it isn’t a given that all legitimate businesses will make a profit. So the IRS gives you another bite at the apple. They consider a number of factors, including:

1, Whether you run your business as a business. This includes keeping good records and promoting your business.
2, How much time and effort you expend in the activity. It should go without saying that only spending minimal time and effort on your business sends a message that you’re not so serious about it.
3, Your level of expertise. How much do you know about your business?
4, Your track record. What kind of success or failure have you had in other similar endeavors?
5, Your financial picture. A bona fide business is generally something that a taxpayer relies upon to make a living.
6, Whether you continue to change your business practices in order to make money. When things aren’t going so well in business, business owners switch gears. As your financial picture changes, your business practices should, too.
7, The nature of your losses. All start up businesses expect a few bumps at the beginning. However, continuous losses that may be within your control to change would not be acceptable in a bona fide business.
8, Whether you expect the value of your business to grow. This includes accumulating appreciating assets.
9, How much fun you’re having. Oh yeah. In Kochlar, the Court mentions that her Mary Kay sales “...had a substantial component of personal pleasure.” The IRS looks at whether you enjoy yourself. There’s nothing wrong with liking what you do – but if you like it to the exclusion of working at it, you’re going to raise some eyebrows.
So where did Brenda Konchar go wrong? She didn’t operate her Mary Kay activities like a business. She didn’t effectively promote the business – she didn’t even have business cards – and most of her customers were family and friends. She mixed her business assets with her personal assets. She sold her products to friends at or near cost, and lost money year after year and made no substantial steps to make changes. As a result, her business losses were disallowed.

Here’s the lesson to be learned: if you’re going to operate a business, treat it like a business.

H&R Block does individual returns, as well as business returns: We even prepare C-Corp. And S-Corp. Returns for large national companies.

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