Monday, August 31, 2009

Hobby Losses: Background.

As most business owners will tell you, the Internal Revenue Code allows a business to deduct expenses which are incurred in a trade or business or for the production or collection of income. However, for these expenses to be fully deductible the activity must be engaged in with the intention of making a profit. That is, the activity must be a business and not a hobby.

Internal Revenue Code Section 183 contains the general principle of the hobby loss rule. Section 183 limits expense deductions if the business under scrutiny is determined not to be engaged in for profit. An “activity not engaged in for profit” means “any activity, other than one with respect to which expense deductions are normally allowed.” This unhelpful definition does little to tell a business owner what they need to do to avoid being classified as a hobby. One must turn to the related Treasury Regulations to understand how this rule is applied.

Later posts to this blog will shed more light on the factors used in considering the hobby issue. Before discussing the factors, however, it is helpful to know the impact of a business being reclassified as a hobby. In general, if a business is determined to be a hobby, any deductible expenses of the activity will be limited to the amount of income from the activity. This means that the activity cannot generate losses to offset other income shown on a tax return.

As an example, assume that a taxpayer has a day job and a side business. The side business has yet to be successful and has suffered losses for the last 5 years. Those losses were reported on a tax return and reduced the overall taxable income of the taxpayer such that he/she receives a substantial tax refund year after year. If the IRS determines that the side business is really a hobby, all of those losses will be denied. This means that the day job income will no longer be reduced by the losses and the previously offset income will be subject to tax…and penalties…and interest.

Friday, August 28, 2009

Friday’s Tax Quote – August 28, 2009

Today’s quote comes from Bruce the Tax Guy over at the quality tax law blog

"Next to being shot at and missed, nothing is quite as satisfying as an income tax refund."

- F. J. Raymond

Back in November 2008, Bruce compiled an anthology of tax quotes that you can read by clicking here.

Thursday, August 27, 2009

Is Your Business A Hobby? The IRS Might Think So.

This post is the start of a series on what are known as the Hobby Loss Rules. When audited, if the IRS determines that your business is really just a hobby it can result in a substantial tax liability that you and your business simply cannot afford. However, knowing the rules concerning when an activity constitutes a “business” or a “hobby” (called an “activity not engaged in for profit”) can help you structure your business affairs to defend against a hobby loss audit.

The IRS has stepped up its enforcement action in asserting that businesses are hobbies. In fact, earlier this year the IRS released an updated publication for auditors to provide guidance in conducting hobby loss audits. Click here for the audit guide.

In the upcoming weeks, check back on this blog to read more about what the hobby loss rules say and how you can use these rules to defend against a potential audit. To see all the posts discussing hobby losses, click on the “Hobby Losses” link at the bottom of this post.

Tuesday, August 25, 2009

Think the Interest on Unpaid Wisconsin Tax Liabilities is too High?

Many clients with outstanding Wisconsin tax liabilities understand that they owe the tax but ask “is there anything that we can do about the interest?” The reason for this question is that Wisconsin is permitted to charge interest of 18% on delinquent tax liabilities.

The statutory language in Wisconsin Statutes Section 77.60(2) provides the relevant language for sales taxes -- “delinquent sales and use taxes shall bear interest at the rate of 1.5% per month until paid.” Unfortunately, no statute provides for the waiver or abatement of the applicable interest charges, and the courts do not have jurisdiction to review the interest charged on delinquent taxes. Thus, the interest charges included in an assessment are required by statute and there is nothing that can directly be done about the interest on a Wisconsin tax liability.

The way to attack an interest charge is to contest the underlying tax liability. If the tax liability can be reduced, the related statutory interest goes down. But trying to argue for a reduction in interest because there was a reasonable cause for the tax liability having gone unpaid will not be successful. Rather, any argument that there was reasonable cause for the unpaid tax liability is best reserved in an argument for the abatement of penalties or collection fees (which can be done).

Friday, August 21, 2009

Friday's Tax Quote - August 21, 2009

"In my own case the words of such an act as the Income Tax, for example, merely dance before my eyes in a meaningless procession; cross-reference to cross-reference, exception upon exception –couched in abstract terms that offer no handle to seize hold of – leave in my mind only a confused sense of some vitally important, but successfully concealed, purport, which it is my duty to extract, but which is within my power, if at all, only after the most inordinate expenditure of time."

- Learned Hand

Friday, August 14, 2009

Friday's Tax Quote - August 14, 2009

"Natural rights, so called, are as much subject to taxation as rights of less importance."

- Benjamin N. Cardozo

Friday, August 7, 2009

Friday's Tax Quote - August 7, 2009

"Put not your trust in money, but put your money in trust."

- Oliver Wendell Holmes Sr.