IS MORE FUN WHEN IT’S "TAX DEDUCTIBLE"
The ultimate tax shelter: owning your own business!
The No. 1 way
to reduce your taxes is to convert personal expenditures into
allowable deductions. Turn even a hobby into a business and
you'll cut your tax bill.
This is part
of what we call the ultimate tax
strategy—that of converting personal expenses into legitimate
business expenses. To win this game, you must own your own
This is not
complicated, expensive, or difficult to do and incorporation is
Let's see how.
a "profit motive" is the key
To be in business, you merely declare it. And by doing
so, you can turn personal expenses into tax deductions.
If you want to operate in a non-corporate format, as an
individual proprietorship, but under a different name
than your own, no problem. It's easy.
In some states,
you may have to file a "DBA" (doing business as) form
with your local county clerk. Basically, you just fill out a
form with your name, address and the assumed name under which
you're doing business. For example, I might be "John
B. Distributor DBA The Home-Based Business Associates."
Here's the best part: Your business doesn't have to make
a profit for your expenses to be deductible. All you have
to do is establish a "profit motive". Under
the Internal Revenue Code, a "profit motive" is
presumed if you earn any net income in any three out of five
and expected that new businesses probably won't make a profit in
the early years. In fact, in the early years, you can insist
that the IRS defer any challenge for the first five years as to
the legitimacy of your business by filing Form 5213. Remember
you don't have to show a profit — just a "profit
In one case,
despite 20 years of losses, the court found a profit objective
and allowed the deduction of business losses in full for one
company. The case was not unusual. The test for deductibility is
whether you have an actual and honest profit objective. You need
not have a reasonable expectation of a profit.
While the Tax
Court requires a primary or dominant profit motive, the U.S.
Claims Court has held that having a reasonable chance to make a
profit, apart from tax considerations, will suffice.
The test is
subjective: Was your intent to earn a profit?
IRS looks at the following factors to decide if your
intentions are honorable:
manner in which you carry on the activity;
expertise and the expertise of your advisers;
time and effort you expend in carrying out this
expectation that the assets used in your business
may appreciate in value;
success in carrying on similar or dissimilar
history of income and losses with respect to the
amount of occasional profits, if any, that are
elements of personal pleasure and recreation. That
doesn't mean that just because you enjoy doing your
"job" that the expenses aren't
tax-deductible. The Tax Court has ruled that
"suffering has never been made a prerequisite
for deductibility." Moreover, even if you're
employed full time elsewhere, that doesn't prevent
you from having another vocation on the side. Many
people work a full-time job while running a second
business on the side. This technique works whether
your business is your primary source of income or
it's a sideline.
Your hobby can be a
That means your hobby could qualify as a business. In the
process, you'll cut your tax bill.
For example, there was a man who raced stock cars as a hobby.
When he went to see his accountant, they converted his
"hobby" into a business. He had cards and stationery
printed. He ran ads looking for a sponsor. He gave what once was
his hobby the image and appearance of a business and he
demonstrated a real profit motive. He wanted to make money.
This person had a salary from his primary job of $40,000 a year.
When his new business expenses were deducted, not only did he
pay zero taxes but he qualified for the earned income credit, so
the IRS actually paid him.
Two years later, he was audited for that year's return. The law
requires that you prove your business expenses, with receipts,
checks or a journal that's regularly updated. Unfortunately, he
had none of these for the first year. His expenses, however,
were legitimate, and he had the receipts for the subsequent two
years. On the basis of the receipts for the two subsequent years
not in question, this taxpayer with $40,000 in other income and
no receipts, after an IRS audit, paid less than $100 in taxes,
including penalties and interest. Had he kept the records for
the first year, he would have paid nothing.
to qualify as a business deduction.
To qualify as business deductions, your expenses must
and necessary — defined by the courts and the IRS
as "reasonable and customary,"
or incurred during the taxable year, and
with the conduct of a trade or business.
The term "reasonable and customary" depends on your
specific business and the business customs in your locale. The
expenses don't have to necessarily be reasonable and customary
to you, but simply to your particular trade or industry. There
are innumerable cases of "hobbies" converted into
"businesses" with expenses allowed. In one case,
a husband and wife produced, exhibited and sold their sculptured
works. Their expenses were considered ordinary and necessary
business expenses. In another case, a coal miner operated a
kennel for bird dogs. For 11 consecutive years, he lost money.
the courts allowed the deductions and the losses because there
was a profit objective. In a more recent case, a high
school teacher's golfing activity was declared an activity with
a profit motive, so he could legally deduct what once was his
on your profit-making motive.