Archives for July 2013

Hobby or Business in the Eyes of the IRS

Statistics are showing that the number of home businesses and side businesses has been growing of late as the economy has turned south. In reviewing legal resources from such places as Legalzoom, you will soon discover that tax law is among the most challenging portions of our legal system.

You would be wise to consult with a professional when it’s time for your tax payment, but having information before you meet is also beneficial. To be able to take out your business deductions, you must demonstrate that you actually have a business endeavor. Here are some of the factors that the IRS will look into to determine whether you are just running a hobby business versus a real business.

Hobby Business Versus Business Endeavor

The first thing that you must do is be involved consistently and regularly with the business—check out resources like Legalzoom for a more detailed insight. Its primary purpose must be to pursue profit, though it is not necessary that you make a profit in the first few years or so.

After this, the government will look to the following factors:

  • The manner you use to carry out this business and whether it is professional
  • The expertise that you have in the business and its development
  • Whether you expect the assets used in the business to appreciate or depreciate in value
  • Whether you have had success in the past over similar activities and whether you have a history of profits and losses
  • The amount of profit that you have made versus the number of years you have been doing this
  • The financial status of the business
  • How much pleasure you get from this activity with the belief being that the more you enjoy it, the less likely it is an official business

Demonstrating Your Position

It’s essential that you keep good records in this matter. Be sure to keep all of your receipts and consider your write offs carefully. You are more likely to be scrutinized if you take excessive write offs without making a profit, and you do not want to be visited for an IRS auditor.

If you cannot keep physical records, at least scan all of your receipts, meeting notes, and the like so that you have virtual copies available. Then make sure that you back it off in a separate place to make sure that they don’t get lost.


Managing Your Cash Flow

The most difficult part of becoming an entrepreneur and opening your own business is having the cash to make it all happen.  As a finance blogger I make a little money on the side and consider myself to be a bit of an entrepreneur myself, but keep in mind that while my financial returns are minimal so is the amount of capital I needed to invest.  Unfortunately most brick and mortar businesses require quite a bit more capital to get started, and most won’t see a financial return for many years, if ever.  This is why it’s important to save cash wherever you can.

I have seen business owners who tend to be leery about outsourcing too many of their much needed services, but sometimes early on this is the way to go.  Putting an accountant on the payroll full time is a waste of money, and could lead to a bigger expense than if you simply paid an outside accounting agency an hourly fee to handle your simple bookkeeping.  Likewise, payroll is an important task, but not one that absolutely needs to be handled in-house.  Consider companies like ADP, there is a reason why they are so successful.  Businesses realize there is a limitation to what they can do themselves, and the successful ones know when to outsource their much needed tasks.

Company cars are another area of low hanging fruit. I have worked for companies large and small over my career, and the company car is at the forefront of any business.  Whether you view it as a nice employee perk, or an absolute business necessity, they will most likely be a fixture for just about any business.  Some established companies with a ton of free cash flow might opt to buy these vehicles outright, but in most cases vehicle leasing is the answer.  The monthly cost is more manageable than buying them all outright with upfront cash.  There are favorable tax impacts, and your employees will most likely be thankful that they aren’t using their cars for company business.   Some companies like Leasing4Business offer good prices on group leasing deals.

Creating a successful business plan is too often the area that new business owners fail. They don’t realize that cash forecasting and planning is truly the way to sustain business operations early on.  Sure a business plan is always important, but business critical tasks can make or break a new company when they are just starting out.  In fact, I would recommend that you not even open your doors for business without a valid business plan written up first.