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 WILL THE IRS CONSIDER YOUR BUSINESS TO
BE ENGAGED IN FOR PROFIT?
If the IRS determines that your
business is not engaged in a profit making activity, they may disallow losses or
deductions. 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 or not an activity is a trade or business. Regularity of activities and
transactions and the production of income are important elements. You do not need to
actually make a profit to be in a trade or business as long as you have a profit motive.
You do need, however, to make ongoing efforts to further the interests of your business.
Among the factors which should normally be taken into account are the following:
1. Manner in which the taxpayer carries on
the activity.
The fact that the taxpayer carries on the activity in a businesslike manner and
maintains complete and accurate books and records may indicate that the activity is
engaged in for profit. Similarly, where an activity is carried on in a manner
substantially similar to other activities of the same nature which are profitable, a
profit motive may be indicated.
2. The expertise of the taxpayer or
his advisors.
Preparation for the activity by extensive study of its accepted business, economic,
and scientific practices, or consultation with those who are expert therein, may indicate
that the taxpayer has a profit motive where the taxpayer carries on the activity in
accordance with such practices
3. The time and effort expended by the
taxpayer in carrying on the activity.
The fact that the taxpayer devotes much of his personal time and effort to carrying on
an activity, particularly if the activity does not have substantial personal or
recreational aspects, may indicate an intention to derive a profit.
4. Expectation that assets used in
activity may appreciate in value.
The term "profit" encompasses appreciation in the value of assets, such as
land, used in the activity. Thus, the taxpayer may intend to derive a profit from the
operation of the activity, and may also intend that, even if no profit from current
operations is derived, an overall profit will result when appreciation in the value of
land used in the activity is realized since income from the activity together with the
appreciation of land will exceed expenses of operation.
5. The success of the taxpayer in
carrying on other similar or dissimilar activities.
The fact that the taxpayer has engaged in similar activities in the
past and converted them from unprofitable to profitable enterprises may indicate that he
is engaged in the present activity for profit, even though the activity is presently
unprofitable.
6. The taxpayer's history of income or
losses with respect to the activity.
A series of losses during the initial or start-up stage of an activity
may not necessarily be an indication that the activity is not engaged in for profit.
However, where losses continue to be sustained beyond the period which customarily is
necessary to bring the operation to profitable status such continued losses, if not
explainable, as due to customary business risks or reverses, may be indicative that the
activity is not being engaged in for profit.
7. The amount of occasional profits, if
any, which are earned.
The amount of profits in relation to the amount of losses incurred,
and in relation to the amount of the taxpayer's investment and the value of the assets
used in the activity, may provide useful criteria in determining the taxpayer's intent. An
occasional small profit from an activity generating large losses, or from an activity in
which the taxpayer has made a large investment, would not generally be determinative that
the activity is engaged in for profit.
8. The financial status of the
taxpayer.
The fact that the taxpayer does not have substantial income or capital
from sources other than the activity may indicate that an activity is engaged in for
profit.
9. Elements of personal pleasure or
recreation.
The amount of profits in relation to the amount of losses incurred,
and in relation to the amount of the taxpayer's investment and the value of the assets
used in the activity, may provide useful criteria in determining the taxpayer's intent. An
occasional small profit from an activity generating large losses, or from an activity in
which the taxpayer has made a large investment, would not generally be determinative that
the activity is engaged in for profit.
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