Common Situation I suspect?

[erchess]

A taxpayer who cannot be claimed as a dependent by parents because of the gross income and age tests operates what is at least alleged to be a Sch C Business in a line of work that is almost always followed as a business. He does go out on an average of a job a week although his fees for jobs are lower than those of most in his field. This has been going on several years. There is a pattern of rising revenue and shrinking expenses but so far expenses have always exceeded revenue. There is no question that taxpayer is getting majority of support from parents.

My reaction has been that the expenses may not be claimed because they were paid using the parents' credit cards. On the other hand I have ticked boxes in my software to stop EIC on the grounds that claiming it would open an undesirable can of worms. I have always included in the e-filed returns a note as to why there are no expenses and EIC is not being claimed. I have not heard anything bad from the IRS about the situation. Client is ok paying the SE Tax but I still find myself considering two different changes.

I am considering trying to persuade the guy that he has a hobby not a business. That would avoid SE Tax and he could seamlessly go back to filing a Sch C when he starts paying his own business expenses. I am also honestly considering filing for the EIC which at least last year would have offset most of the SE Tax but not resulted in a refund.

[taxmom34]

wasn't there something a few years back from IRS that said if a loss for last 3 or 5 years you are considered engaged in a hobby. I'm not sure about the # of years, but had a client (while at HRB) that was race car driver and he came up with gain every third year.

[snowshine]

I think the answer to your question is does he operate the business in a, "Business-like," manner. If not, he really is a hobby and shouldn't even be paying SE (much less getting EIC.) As looking to increase sales (which doesn't seem likely from your description) and showing a profit are 2 of the factors the IRS considers I would never do anything except put the income on line 21 until he can show me a profit!

[erchess]

Factors

Thank you both for responding.

I have some other factors that I didn't spell out. The fellow has a certificate from the local community college in what he does and licenses from the state proclaiming him to be a skilled tradesman and a contractor. He averages about one job a week and averages spending six to eight hours on the job but he spends the rest of a fifty hour week working on promoting his business by such things as signs on community bulletin boards, doorknob hangers he and people he pays put out and some overly expensive websites. He also has revenue exceeding COGS. His problems as I see it are as follows.

He doesn't charge enough for the jobs. He did some work for me and his revenue worked out to be 15 bucks an hour plus materials.

He pays more than most contractors for his parts because he isn't busy enough to qualify for as much of a discount as most of his competitors get. That will of course be self correcting if his advertising is successful..

He spends way too much for his advertising for what he gets. For example his web presence consists of a number of sites he bought at an all day sales pitch in a hotel and he is paying more for each of his sites where he does the work than I do for my site where other people do most of the work. Of course his sites will let people make appointments with him and pay when he is done. My site doesn't let people do either. He also gets his letterhead business cards and door hangers and fliers too expensively. When I do fliers I design and print them myself. He pays someone to help him design them and to print them for him.

[Kram BergGold]

My view

First, he is clearly operating a business. From your description his activities are not a hobby.
Second, to me, the expenses his parents pay for are gifts to him. If they spent more than $13,000 they would have to file a gfit tax return. So again, to me,. he should get to deduct them.
Third, if he qualifies for EIC he should get it.

[erchess]

Food For Thought

If we include on his C the expenses paid by his parents then he has a loss. My feeling has been that since he probably can't claim those expenses which he did not pay he should show a profit and pay tax on it but not claim EIC because he doesn't really have a net profit.

On the other hand one of our more learned members thinks he CAN claim the expenses and thus I believe would have an NOL. That could save him some money in the future.

It also occurs to me that if his parents gave him cash and he used that to pay his expenses then clearly he would be entitled to claim the deduction. Perhaps the economic substance doctrine would mean that giving him permission to use their credit cards is the same thing.

[ChEAr$]

If we include on his C the expenses paid by his parents then he has a loss. My feeling has been that since he probably can't claim those expenses which he did not pay he should show a profit and pay tax on it but not claim EIC because he doesn't really have a net profit.

On the other hand one of our more learned members thinks he CAN claim the expenses and thus I believe would have an NOL. That could save him some money in the future.

It also occurs to me that if his parents gave him cash and he used that to pay his expenses then clearly he would be entitled to claim the deduction. Perhaps the economic substance doctrine would mean that giving him permission to use their credit cards is the same thing.

If push came to shove, i.e. in event of IRS audit, I think IRS would disallow those credit
card expenditures as expenses, reason being involved with the at risk rules somehow.

Best idea then is for parents to give the son money to pay his expenses.