Paldino Company CPA - "Success Starts with a Handshake"

Welcome to my blog page the purpose of which is to provide you with timely and relevant tax and accounting information. I intend to bring you information which you can use now to assist you in lowering you income taxes. I will when appropriate give you links to tax related web-sites, worksheets and check-list to assist you in meeting you recording keeping requirements and provide you with the information you need to prepare an accurate return and pay the least amount of tax you are legally required to pay. Please check back often and feel free to post your questions and comments















Monday, December 17, 2012

How to ensure your business is not deemed a hobby



You Can't Deduct that Loss. It's a Hobby.




You’ve loved dogs all your life so you decide to breed them and start a dog training business. Is this a business in the eyes of the IRS or a hobby? Knowing what the IRS is looking for and properly positioning your small business can save taxes and headaches if you are ever questioned by the IRS.

Why should you care?

If your activity is a business your income can be reduced by all your qualified business expenses even if it results in a loss. If your activity is a deemed a hobby, no losses are allowed on your tax return. Furthermore, your hobby expenses are treated as miscellaneous itemized deductions and do not count until they (and other miscellaneous expenses) surpass 2% of your income.

Tips to make it a clear business

Here are some simple tips to ensure full deductibility of your expenses against your business income.
  1. Profit motive. You must show that you intend to make a profit with your activity. The old rule of thumb was to show a profit at least three out of the past five consecutive years to safely qualify your activity as a small business. But this is no longer the case. Although more difficult to substantiate, you can show profit motive without ever showing a profit by your ongoing activities around the business.
  2. Active participation. You need to be actively involved in your pursuit for success. If you simply invest money in the dog business, but are never there to care for them or give lessons, you will have a hard time justifying the business nature of the activity.
  3. Be professional. Businesses have separate checkbooks, business cards and stationery. They have financial statements and show the same disciplines one would find in a “for profit” venture of the same type of activity you are pursuing.
  4. Pleasure factor management. If your business has a large enjoyment factor, you will need to be even more cautious about having proper records. Ideally the pleasure factor is secondary to running your business. If you claim to be a golf pro giving lessons, but then spend all your time playing golf, you will have a hard time justifying the activity as a true business.
  5. Have multiple customers. If you only have one or two customers, who also happen to be relatives, your activity may be deemed a hobby. Having a number of customers, even without profits, can make all the difference in allowing for expense deductions.
  6. Showing profit motive without profits - Part II. How else can you show profit motive when no profit is to be found? Advertising is one way to do this. Keep copies of all ads trying to drum up business. Keep a daily diary of business activities, noting who you meet and for what purpose. Create and keep sample product, even if it is not yet sold.
  7. Understand your risk. There are certain business types that are under the IRS microscope when it comes to hobbies. Key among these are multi-level marketing businesses like Amway, Tupperware and Avon. It also includes the thousands of part-time sellers of goods on internet sites like e-bay. If you are in one of these business activities you will need to prove the business nature of your involvement and be prepared to be challenged.

Quick Checklist

Wondering if your business activity may be considered a hobby? Review this checklist. The more yes answers, the better your chances of defending your position.
  • Conducted activity in business-like manner?
  • Have expertise in your activity?
  • Put time and effort into the activity?
  • History of income/profits?
  • Have had prior success in a similar activity?
  • Is there a low element of pleasure/recreation involved?
  • Are there appreciating assets or an expectation that there will be?
Remember, having a business activity reclassified as a hobby can mean a big tax bite at tax time. But by keeping proper records and pro-actively knowing the pitfalls, you can avoid most problems.

Tuesday, December 11, 2012

What to do about your need for documentation



No Check! Where's Your Proof?






Year-end is a good time to ensure you have proper documentation to substantiate your tax deductions. This is important as many banks start deleting online documentation that is over one year old.

Background

Two things have happened over the past ten years that have greatly reduced the ability to have a canceled check as proof when the auditor comes calling. The first is the advent of online bill paying services. The second is a regulation that was passed in 2003 commonly known as Check 21. With online bill paying, you pay a bill via an online banking service. Your only receipt is often just an entry in your checking account. With Check 21, the law allows banks to digitally capture the check and then destroy the paper copy without returning it to you. So what do you do if you need proof that you paid for a tax deductible item?

Some Tips

  • Know your bank. Understand what your bank keeps and for how long. This includes digital statements and digital copies of checks (both front and back). Understand if there are any fees charged if you need to request copies of payments.
  • Retain copies of all bank statements. Review your records to ensure you have copies of all monthly bank statements. This is often the starting point for an IRS agent that wants proof of payment, so it should be yours as well. These copies may be in either paper or digital format. Download online copies of your statements and place them in a password protected file.
  • Collect copies of tax related proof of payment. Go through your statements and mark the payments that will, in all likelihood, be used as a tax deduction. Make sure you have copies of the front and back of each of these payments. If you do this work now, the copies are often still available online for no fee. Even online bill payments often have a digital copy that can be used.
  • Get independent acknowledgements. If you have larger payments you should also make sure you have independent acknowledgement from the merchant or organization to substantiate the deduction. This is true for charitable contributions of $250 or more, and any business or medical expenses.
While having the traditional "proof" of an expenditure is now harder to come by, the IRS understands that approved technologies are changing the type of substantiation available for them to review. By being on top of this documentation at the end of each year, you can save yourself a lot of headaches should you ever need to prove your deductions.