Q:  IRS rules say that a business must show a profit 2 or 3 years out of 5 years. My tax preparer says that if you are actively trying to build a business, that does not apply…that I can still take all my deductions and show a loss. What is your opinion on this?

A:  Actually, the rule is that if your business is profitable for 3 out of the last 5 years, then the IRS will presume that the business is carried on for profit, and is not a hobby.  That means if you aren’t profitable for 3 out of 5 years, the IRS MAY reclassify your business as a hobby, but that doesn’t mean that they will automatically determine that it’s a hobby.

It’s important that you treat your business like a business and not a hobby because if the IRS determines that you have a hobby you will have to report that hobby income, but you may not be able to deduct all the expenses you would be able to deduct if you have a business.  If you don’t itemize your deductions, then you could lose the ability to deduct ANY expenses!

Also, many businesses incur a loss in the first year or two of business.  If the IRS determines that you have a hobby instead of a business you won’t be able to deduct those losses.

Things to do to keep from being classified as a hobby include:

* get a tax ID number
* keep separate business and personal checking accounts, credit cards and PayPal accounts too
* register a business name
* hire an accountant, attorney or coach
* create a business plan
* keep track of the time you spend in your business and what you do

So… just remember that the IRS will make exceptions to the hobby loss rules, even if you have a loss for more than 2 years, if you treat your business like a business and not a hobby.

For more great questions and answers about online business taxes, please see ‘Your Top Online Biz Tax Questions Answered’, my new audio/ebook program for online and home based business owners.

Related Posts:

• Do I Have To Report My Online Income?
• List of Tax Deductions for Online Biz Owners
• Can I Deduct Internet and Phone Expenses?

Q:  I just started my home based business this year and expect to just break even this year. Do I still need to report my income, even if I don’t actually make a profit?

A:  Yes, you must report all income earned.  It’s a common misconception that if you don’t earn much or if you’re just doing it as a hobby that it’s not reportable or taxable.  That’s not true.  All income is reportable from the first dollar earned.

It doesn’t matter if you receive a 1099 or not.  It also doesn’t matter if you earn less than a certain amount.  Another myth is that if you earn less than $600 you don’t have to report the income.  Again, it’s just not true.

You are allowed to deduct business expenses from your income, so in your case, just because you have to report the income doesn’t mean you’ll have to pay any taxes.  If you have expenses that are as much as or greater than your income, you won’t owe any taxes, and may even be able to use that loss to reduce other taxable income.

Got more tax questions about your home based or online business?  Check out ‘Your Top Online Biz Tax Questions Answered’, a new audio/ebook program for online and home based business owners.

Related Posts:

• Q&A: Can I Deduct My Expenses If My Online Business Has a Loss?
• List of Tax Deductions for Online Biz Owners
• Can I Deduct Internet and Phone Expenses?