Friday, December 9, 2016

Avoiding Hobby-Loss Restrictions

Like many of us, you've probably dreamed of turning a hobby or avocation into a regular business. You won't have any unusual tax headaches if your new business is profitable. However, if the new business consistently generates losses (deductions exceed income), the IRS may step in and say it's a hobby (an activity not engaged in for profit) rather than a business.

What are the practical consequences? Under the so-called hobby loss rules, you'll be able to claim certain deductions that are available whether or not the business is engaged in for profit (such as state and local property taxes). However, your deductions for business-type expenses (such as rent or advertising) will be limited to the excess of your gross income from the hobby over those expenses that are deductible whether or not the business is engaged in for profit. Deductible hobby expenses are claimed on Schedule A of Form 1040 as miscellaneous itemized deductions subject to a 2%-of-AGI "floor."

There are two ways to avoid the hobby loss rules. The first way is to show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing, or racing horses). The second way is to run the venture in such a way as to show that you intend to turn it into a profit-maker, rather than operate it as a mere hobby. The IRS regs themselves say that the hobby loss rules won't apply if the facts and circumstances show that you have a profit-making objective.

How can you prove that you have a profit-making objective? In general, you can do so by running the new venture in a businesslike manner. More specifically, IRS and the courts will look to the following factors:
  • how you run the activity
  • your expertise in the area (and your advisers' expertise)
  • the time and effort you expend in the enterprise
  • whether there's an expectation that the assets used in the activity will rise in value
  • your success in carrying on other similar or dissimilar activities
  • your history of income or loss in the activity
  • the amount of occasional profits (if any) that are earned
  • your financial status
  • whether the activity involves elements of personal pleasure or recreation

The classic "hobby loss" situation involves a successful businessperson or professional who starts something like a dog-breeding business, or a farm. But IRS's long arm also can reach out to more commonplace situations, such as businesspeople who start what appears to be a bona-fide sideline business.

Please contact our office to get more details on whether a venture of yours may be affected by the hobby loss rules, and what you should do right now to avoid a tax challenge.

Friday, December 2, 2016

ALERT – Deadline Change for Information Returns

A new federal law has moved up the filing date for W-2s and certain 1099 forms.  Under the new law, employers (and paid preparers) must submit copies of these forms to the IRS and SSA by January 31.  This change is effective with the 2016 information forms that will be due on January 31, 2017.  The accelerated deadline is intended to help the IRS spot errors on returns and make it easier for the IRS to verify the legitimacy of tax returns filed.

Previously, a copy of these forms was required to be provided to recipients by January 31, but employers (and paid preparers) had until the end of February (if filing on paper) or March (if filing electronically) to send copies to the Internal Revenue Service (IRS) and the Social Security Administration (SSA).

A 30-day extension is available for IRS submission.  If an extension is necessary, Form 8809 Application for Extension of Time to File Information Returns must be completed as soon as possible, but no later than January 31.