Tax Help - Do You Have a Profit Motive?

Schedules C, E and F

Do you file either of these forms on your yearly return?

A trade or business is generally an activity carried on for a livelihood or in good faith to make a profit.

The facts and circumstances of each case determine whether an activity is a trade or business.

The regularity of activities and transactions and the production of income are important elements. Taxpayers do not need to actually make a profit to be in a trade or business as long as they have a profit motive. Taxpayers do need, however, to make ongoing efforts to further the interests of their business.

The IRS is wary of taxpayers who have years of consecutive losses in their business. While there are businesses where long-term down turns occur, it is possible for the IRS to question their profit motive if they have losses year after year. It is important that you be able to substantiate your expenses and efforts to turn a profit in your business endeavors.

No Income Reported or Large Amounts of Deductions

Business expenses are the cost of carrying on a trade or business. These expenses are usually deductible if the business is operated to make a profit. To be deductible, a business expense must be both ordinary and necessary.

An ordinary expense is one that is common and accepted in a taxpayer's trade or business. A necessary expense is one that is helpful and appropriate for a taxpayer's trade or business. And expense does not have to be indispensable to be considered necessary.

Taxpayers with large deductions and expenses that tend to "zero out" their profits year after year may come under increased scrutiny from the IRS. While many businesses have large expenses in their first year of operations and in years of transition, few have expenses that equal their incomes year after year.

Make sure that you understand the differences between business expenses and personal expenses. If questioned by the IRS, you will need to be able to substantiate all of your expenses. Expenses that are not ordinary and necessary or that are personal will not be allowed.