business vs hobby

[Questionguy101]

Taxpayer has a business which has been going on for like 30 years. He has done well and made money before. But in the last few years, because of the economy and competition, the business started going downhill and showed a loss in the last 3 years tax return (07,08,09). I guess maybe he is emotionally attached to the business and so he still tries to hang on to it. In this case, does he have a huge chance of getting audited because of the 3 consecutive years loss?

By the way, which year of tax return is being audited now?

Thank you.

[Gretel]

I don't know about chances of getting audited but if he ran this biz successfully since 30 years and now it is going downhill I would not have any doubt in my mind that this is a biz and not a hobby.

A lot of small biz are hit very hard and these conditions need to be taken into account. I am doing a farmers tax return who only had a profit once in nine years. He is well over seventy, working his bud off and was profitable in other decades. When I questioned him some years ago, he said what is he supposed to do but carrying on. He still has all this very expensive equipment.

If your client puts a lot of hours in the biz, nothing about his intent of making a profit has changed.

[JAinNC]

Business goes on even as age increases

I agree with Gretel. l had a client who owed Payroll tax 10000 + during the appontment in my office with collection RA, even the agent took the economy into consideration - Client is still in uncollectible status until next year's review.

JAinNC

[Questionguy101]

I am doing a farmers tax return who only had a profit once in nine years. He is well over seventy, working his bud off and was profitable in other decades. When I questioned him some years ago, he said what is he supposed to do but carrying on. He still has all this very expensive equipment.

Did he get audited in those 9 years?

[S T]

Hobby Vs Business Factors

From IRS Pub 535

Not-for-Profit Activities
If you do not carry on your business or investment activity to make a profit, you cannot use a loss from the activity to offset other income. Activities you do as a hobby, or mainly for sport or recreation, are often not entered into for profit.

The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.

In determining whether you are carrying on an activity for profit, several factors are taken into account. No one factor alone is decisive. Among the factors to consider are whether:

You carry on the activity in a businesslike manner,

The time and effort you put into the activity indicate you intend to make it profitable,

You depend on the income for your livelihood,

Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business),

You change your methods of operation in an attempt to improve profitability,

You (or your advisors) have the knowledge needed to carry on the activity as a successful business,

You were successful in making a profit in similar activities in the past,

The activity makes a profit in some years, and

You can expect to make a future profit from the appreciation of the assets used in the activity.

Presumption of profit. An activity is presumed carried on for profit if it produced a profit in at least 3 of the last 5 tax years, including the current year. Activities that consist primarily of breeding, training, showing, or racing horses are presumed carried on for profit if they produced a profit in at least 2 of the last 7 tax years, including the current year. The activity must be substantially the same for each year within this period. You have a profit when the gross income from an activity exceeds the deductions.

If a taxpayer dies before the end of the 5-year (or 7-year) period, the “test” period ends on the date of the taxpayer's death.

If your business or investment activity passes this 3- (or 2-) years-of-profit test, the IRS will presume it is carried on for profit. This means the limits discussed here will not apply. You can take all your business deductions from the activity, even for the years that you have a loss. You can rely on this presumption unless the IRS later shows it to be invalid.

Based on your OP, your client has been profitable in the past, and just economic times have created the losses , but taxpayer should be prepared to show some positive action on a few of the factors.

To answer the 2nd part of your question, In 2010, I have received a few 2008 CP 2000 notices and I also know a colleague that received a 2008 Audit Notice on Schedule C - so I would say (no guarantee) IRS is looking at 2008 now. 2006 is set to expire if on extension filing, so open years would be 2007 - 2009. You will have to check your State Statute of Limitations for Audit, as some states are 4 years rather than 3 years.

Sandy

[Gretel]

Did he get audited in those 9 years?

No, he didn't. This is the same question I always ask and there is no doubt in my mind that only an audit might proof right or wrong.

I am a very doubtful person to a degree that something rather has the IRS interest in mind than my client's and I refuse to give into that. If all my questions are asked and my gut feeling says, in this case, this guy is still trying to make a profit, I go with it.

[JON]

Hobby

usually comes into to play when you have personal entertainment/use frrom the business. I have a business who has been existence for 15 years and has 10 consecutive loss years.... They work at it - there is no chance it is a hobby. If my owners had other sources of income and did not work there and enjoyed watching/using (cars/horses) then i would be ready for an audit.

[joanmcq]

years being audited

I've been getting audits from 2007-2009 currently; CP2000 notices seem to be mostly 2008, but I'm not working those as much as the full blown audits these days.

Many of the states like NY, MA & MI are pre-auditing more-not sending out suspicious refunds until deductions or credits are proven. I've seen a bit of this on the federal level too, not counting the FTHB credit which, I believe, is being audited 100%.