If you are self-employed or have started your own business while you are still working for someone else, you may have incurred some losses in your business. Schedule C is used to report self-employment income and expenses. If your business legitimately lost money, you can usually deduct the loss. The Internal Revenue Service has some guidelines for how often you can deduct business losses.
Determining if the Activity is "For-Profit"
The IRS has a set of guidelines it will use when assessing your business to determine if it is intended to make a profit or if it is a hobby. If it is a hobby, the IRS will limit the deductions you are permitted to take for losses. If the IRS is trying to determine whether you truly intend to run a business or are just looking for a way to decrease your tax liability, it will look to see if you are investing the time and effort to make a profit. It also will look to see if you are depending on the income from the business.
Source of the Losses
The IRS also will look to see if the losses you are claiming on your Schedule C were because of circumstances beyond your control, or if they were related to startup costs. If your business is losing money, the IRS may also want to know if you have adjusted your business methods to increase profitability. If your business has been profitable in the past, the IRS will look to see how long it's been since you made a profit.
Presumption That Activity Is Engaged for Profit
If your business has been profitable for three out of five consecutive years, the IRS will presume that your activities are for-profit. That does not mean that the IRS will not be careful to examine your books to see if you are trying to manipulate this rule. If your profitable years report small profits with disproportionately large losses in the other years, the IRS may want to take a look at your books to make sure that you aren't manipulating the financial information.
Seeking Advice and Keeping Records
If your business expenses are going to be high enough that you will have a loss on your Schedule C, it is best to consult with a certified public accountant to verify that you are taking deductions properly. If you have a CPA prepare your return, she can help you determine if you have any expenses that the IRS would disallow. Keeping accurate records and documenting your expenses will help if the IRS has any questions about your expenses or if your tax return is audited.
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