What, if anything, is wrong with this sentence?

You have to show more than merely a profit motive. You have to show that you are realistically taking efforts to make a profit. I can play race cars with the "motive" of making money by making quick deliveries for people. But if I don't have the proper business infrastructure, if I don't take reasonable steps to market my service in a way that would generate net income, it's still a hobby.

Stu

If the hobby was turned into a business with a profit motive, the expenditures would no longer be personal. The concept that "personal expenditures" can be legitimately converted into allowable deductions is deceptive.

For one thing, even with a business the expenditures still have to be "ordinary and necessary" in order to be deductible.

-Mark Bole

Taxpayers and the IRS both wield a two-edged sword on this issue. There are times when the taxpayer wants a hobby (an activity not engaged in for profit) to be treated as a business in order to increase deductions and there are times when a taxpayer wants a business to be treated as a hobby to avoid paying self-employment taxes. The IRS has the same desires. I.e., they either want your profit activity treated as a business (Off Line 21 and onto a Schedule C/C-EZ) to increase taxes or they want your activity treated as a hobby to eliminate your Schedule C/C-EZ deductions.

IRC Section 183 and its regulations contain the rules for determining when one has a business or a not for profit activity. Reg. 1.183-2 contains the facts and circumstances tests that are used by the IRS. You can read the Reg. at:

Section 183(d) of the IRC has the IRS presumption test.

I appreciate all the responses but they are more general than what I am looking for. Specifically, is there anything wrong with the quoted sentence?

As the opening of a much broader discussion.. the two sentences are fine. See the link below for the quote and the rest of the article: "The ultimate tax shelter: owning your own business".

If the two sentences are meant to stand by themselves, then they make no sense to me.

Ask Jesse Cota and the other defendants of "Renaissance, The Tax People" about this, then ask them about their indictments (except for Cota, who changed his plea to guilty and agreed to 5 years in prison*). I picked up some of their company's literature in 1998 when they were at (one of, Las Vegas) the IRS Nationwide Tax Forum. It showed you how to convert a $200 hobby gain into a $32k business loss, or "How to commit tax fraud in one easy step."

• - The U.S. BoP Inmate Locator does not list him as currently in custody serving his sentence. U.S. District Court, District of Kansas, Case No: 04-20105-02-CM

Sentencing of one of the four primary defendants in the Renaissance, The Tax People, prosecutions in U.S. District Court has been postponed until July 21. (Source: Topeka Capital-Journal, The, May 27, 2009 by Steve Fry)

the sentence is still open-ended but will NOT be less than 3years.

The most fundamental problem with this thinking is not tax related. If you take something you enjoy and try to turn it into a business, most likely it will cease to be enjoyable.

The second sentence should have a comma after the word 'business'. The alt.usage.english group could maybe give a deeper analysis. :-)

------------------------ >>

Yes, it is wrong if you want to nit-pick the wording. Personal expenses are personal expenses and you cannot convert a personal expense into a business expense. You can only deduct it if it becomes a business expense. Then it would no longer be a personal expense.

For example, if you move out of your home and rent it, the property taxes would no longer be personal expenses.

Well one thing that is wrong with it is that it might be false that this reduces taxes. It can often be a tax disadvantage to report less rather than more business income.

The less business income TP has, the less they can defer into a qualified retirment plan, and so they lose the future-year tax advantages of the funds growing tax-free in the plan. When you crunch through the numbers it is often an economic loss to report more business expenses if you have a long horizon. This is particularly true if TP has maxed out on Social Security tax, and if TP is young; but can be true even if not.

And unrelated to taxes, a lack of business income is disadvantageous in other ways, such as when qualifying for a loan, or when trying to sell the business.

So in the base case, where TP is intelligent and has set up a qualified plan and intends to defer the maximum, there is little advantage to racking up business expenses, and I would say so little advantage to reporting up *questionable* business expenses that it is almost always a losing strategy.

Steve

Here is what I find wrong with the wording of the first two sentences (yes, they are intended to be taken together - my bad).

Background: IRC Section 183 requires an intent to make a profit in order for a taxpayer to deduct expenses in excess of revenue of an activity.

The sentences describe (very clearly, in my opinion) reducing personal taxes as the objective in creating an activity. In general, federal income taxes can be reduced only if taxable income is reduced. In general, taxable income can be reduced by a new activity only if expenses of the new activity exceed revenue of the new activity. Conclusion #1: If the new activity is created in order to reduce federal income tax liability, then the taxpayer does not have an intent to make a profit with the new activity. Conclusion #2: If the taxpayer does not intend to make a profit with the new activity, then only expenses equal to revenues can be deducted. Conclusion #3: If the activity is entered into with the intent to reduce federal income taxes, then the activity cannot be used to reduce federal income taxes.

Now, is that nitpicking? Or is that an argument an IRS tax auditor might use if he/she knew that the taxpayer had used an article containing that sentence as justification for starting a new activity reported on Schedule C (or as a sub-S corporation)? Or both?

Although I did use the article linked to by Alan, as the source, I have seen similar wording used by others over the years. Also, I read the article at another site dated about 5 months later than Alan's reference with no citation to the earlier appearance.

What do you mean by "wrong", since we're playing a guessing game here?

Grammar? Tax law? Financial or lifestyle advice?

Here's one: I don't like the the sentence fragment "Turn even a hobby...". The word "even" doesn't belong, since it implies there are a class of things you can turn into a business, of which a hobby is one of the least likely members (of the class) to result in successful turning. Better to say, "Turn especially a hobby into a business...".

Here's another: the word "surest" is overly strong, as there are many other ways that are equally or more certain to reduce your taxes. Better to say, "A sure way to reduce...".

Here you're talking about "shortcomings" instead of "wrongness". "Mitigate" refers to reducing pain, severity, or harshness. If there is indeed something wrong, I think we would be looking to correct it, not mitigate it.

Next step: why don't you propose an alternative and ask which one is "better"?

-Mark Bole

I don't see the word "intent" anywhere in the statute. Regulation §1.183-2 doesn't really focus on "intention" either. Here are some relevant quotes:

"It is not, however, necessary that an activity be engaged in with the

*exclusive* intention of deriving a profit..." [emphasis added]

In the Prieto tax court case, the taxpayer had to establish "primary, predominant, or principal purpose and intent of realizing an economic profit independent of tax savings." Again, not exclusive -- tax savings could certainly be part of the expectation, just not the principal purpose of the activity.

Consider a new activity that is created (or preferably, "engaged in") primarily because the taxpayer believes it will increase his chances of getting into heaven someday, or perhaps because he thinks the activity will attract more friends and lovers into his life. That would not preclude it from being an activity engaged in with an expectation of making a profit.

I'm sure you're aware of the nine factors that the IRS uses to determine whether or not an activity is engaged in with an expectation of making a profit. They all have to do with how you actually conduct your business, not what you were thinking when you decided to start it.

Another example: it's quite common for businesses to have net operating losses in their first year. Suppose someone deliberately times both the start of a new business and the departure from a high-paying job near the end of one year, rather than the beginning of the next, solely because he knows it will help cut his tax rate in the earlier year. Does that somehow negate his profit motive for the business?

Well, I suppose the IRS auditor can make whatever argument they want, that is why you should hire a good representative if the stakes are high enough to warrant the cost.

One similar situation comes to mind: moving expense deductions. Your reasons for moving may be completely personal and having nothing to do with income production, but as long as you meet the test for working in the new location (and the other tests, of course), your otherwise personal moving expenses are turned into allowable deductions. Your intent had nothing to do with it, just your actions.

-Mark Bole

I find significant similarities between the article Alan linked and the promotional materials of Ren TTP.

By the way, the reason I did not provide more details in my original post is that I wished to exclude my opinions and conclusions from consideration by other readers. I wanted, as much as possible, for readers to form their own conclusions.

Thanks for all the comments (and any more to come).

Expectation of making a profit is NOT a requirement. The history of the legislation makes it clear that Congress explicitly considered and rejected making expectation of a profit be a requirement.

All of those factors are directed at inferring what the tax payer was thinking. Relying upon an article (or promotional materials) that suggest that engaging in a new activity will lower one's taxes causes me to infer that the taxpayer was thinking about reducing taxes, not making a profit (which would increase taxes).

Nope. Additionally, it would be a good fact that the taxpayer no longer had income from that high paying job to be offset by that activity's losses.

Moving expenses are totally irrelevant to my consideration of IRC Section 183. Drawing analogies is the road to paying penalties and interest when it comes to federal income tax law.

Thanks for your comments.

The entire focus of the IRS and of the courts is on determining whether the taxpayer intended to make a profit. The absence of the word, "intent," does not change that fact of life.

It's an important distinction, in my opinion. In the nine factors, do you see any that are based on anything other than what the taxpayer actually does (which directly lead to what outcome he expects)? Although we know it's not they are not a quantitative measure, which of the nine factors would be weakened by a desire to cut taxes?

At one point I had written "intent and expectation are two very different things" but removed it from my reply before sending. You can intend something but have an expectation that it won't work. "I intend to win the lottery as I buy this ticket, but I don't expect I will".

Or, "I intend to run a successful restaurant, but given the bad location and my lack of skills, I don't expect to succeed for at least two years". It's only the failure to change things and thereby raise the expectations that would lead to concluding no profit motive.

Conversely, "I intended to just have fun cooking for large gatherings of friends and family, but when a guest asked if they could hire me to cater a party, and that led to another request, then I began to expect that I could make money doing this."

So, leaving aside word games, if it all boils down to "facts and circumstances" (or "facts and circuses", as I've heard it called sometimes), how could an IRS agent make an argument about reading an article and the taxpayer's intention? Is he going to subpoena Internet search records to try to prove that the taxpayer must have read the article?

Unless, of course, the taxpayer himself says to the agent, "well, I only started the business because I read this article on the Internet that said it would cut my taxes...".

-Mark Bole

You see this with Nurses. RNs are in demand most places (even today). He or she wants to move from current place to somewhere near Mom, Dad or the beach depending on priorities and/or breathing status of the parents. She or he gets a job at NearMom General and moves solely for these other reasons. Still can deduct the moving expenses, assuming all other requirements are met.