Make no mistake, a business can save you a lot in taxes. I had a client who made $50,000 a year as a middle manager. He lost his job and started a consulting business. He made $50,000 in that first year. Income was the same, but the net result was very different. As a business owner, he had an extra $10,000 in his pocket at the end of the year.
The reason is because he had a business, and that meant he got deductions that he couldn’t get as an employee.
There is a new challenge from the IRS for businesses. If you don’t pass this test, you could lose all of your deductions.
It all boils down to one thing:
Do you really have a business?
If you have a business loss, then you need to be particularly aware of this. That’s because the IRS is targeting businesses who report losses. And one of the first things they’ll do is challenge whether you have a business. No business means no deductions.
To do that, the IRS relies on a Nine Factor test. These nine factors can be further simplified to four main categories. How does your business stack up?
1) Do you run your business in a business-like manner?
Some of the things you can do to prove you have a business include:
- A separate business checking account
- Track business mileage on your car
- Keep files and notes on prospects
- Keep accounting separate for your business.
It’s interesting that the things the IRS requires that you do to prove you have a business also make you a better business owner.
2) Do you have past, present or realistic future success? If the answer is no, do you have advisors who do?
The IRS wants to make sure you know what you’re doing. If you don’t have profit now, they’re going to ask if you’ve had profit in this company or another company like it in the past. If not, then they will want to know what you’re doing to ensure success. Here are some of the things that can demonstrate you’re serious about your business if you haven’t had a prior successful business:
- Have a mentor, coach or advisor who has success in this type of business
- Study and attend educational events
- Show a willingness to learn
- Record, analyze and adjust to do more of what’s working and eliminating what doesn’t
3) Are you putting in the necessary time and effort to build a business?
The IRS calls this the “time and effort” category. If you don’t put the time and effort into a business, you’re not going to build it. Yes, I know, there are a lot of gurus out there who can tell you that you can get rich quick by being lazy. But the fact is that your business needs time and effort at the beginning. Sure, you’re likely to show a tax loss, but the time and effort prove that you are working at changing that.
Prove you’re putting in the time and effort by keeping a calendar. If your business is part-time, then follow minimum requirements set by the IRS. They have said that a part-time business where the owner works in it 2 or more evenings a week and two weekends a month is sufficient to prove this.
4) Do you have a profit motive?
The final category, #4, is the toughest. The best way to show you have a profit motive is to actually have a profit. If you had a profit, then you wouldn’t even be questioned by the IRS. That’s because this is a test for companies who have a loss.
Some of the additional questions that the IRS will ask is whether you are making changes you need to do to get a profit. Do you have outside income that means it doesn’t really matter whether you have a profit? Are you building assets that you reasonably expect to appreciate?
If you have outside income and can’t demonstrate that you’re trying to do something about profit, then you have a problem. You may flunk this past category and that could mean you lose your tax breaks.
Some things that will help prove you’re serious about turning a profit:
- Demonstrate that you regularly review your business’s financial stats and make changes
- Have an experienced mentor or advisor whose advice you take
- Change what you’re doing
- Do more of what works
- Do less of what doesn’t
- Build assets like silver, gold or real estate.
A business can save you a lot in taxes. A business can be you door to financial freedom. Or you can quit. The choice is yours.
About The Author
Diane Kennedy, CPA helps business owners legally pay less tax. She’s the New York Times best-selling author of “Loopholes of the Rich”, “Real Estate Loopholes”, and 7 other best-selling financial and tax books. She’s also a business owner and real estate investor. Her motto is “It’s Your Money. Keep More Of It.” Learn more about Diane by visiting USTaxAid.
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