There is no better way to enjoy tax benefits than starting up a small or home-based business. This is why Chapter I of my book, Lower Your Taxes—Big Time is entitled, “Why you would be brain dead not to have a home-based business.”
The reason is that the government gives you great deductions that employees don’t normally get. Even better, the government, in both the US and Canada, subsidizes your business in several ways:
— If your business generates a loss, you can use that loss against any other form of income. Thus, if you earn $50,000 from a job and have a loss from your side business of $10,000, you only pay taxes on the net, which is $40,000.
— If your loss exceeds your income for the year, you can carry back business losses two years and get back taxes that you paid to the federal and state government over the last two years. ( In Canada, the carry back is 3 years!)
— Finally, any excess loss can be carried over up to 20- years!
HOWEVER, this all assumes that you are running your small business like a business and NOT like a hobby. If the IRS or the CRA in Canada treats your endeavor like a hobby, you will suffer some real pain that may need some aspirin.
First, all income gets reported on your tax return.
Secondly, deductions in US must be reported as an itemized deduction that can only be taken if it exceeds 2% of your adjusted gross income ( which means that you will lose some deductions).
Third, no losses are allowed from hobbies. Thus, you can’t take the loss from a hobby against any other form of income.
Finally, and worst of all, you can have all your deductions disallowed if you are subject to the alternative minimum tax, which means no carryover of the unused loss.
Here are some examples:
— You gross $200,000 from your business that has $100,000 of expenses, If you are a business and are in the 33% tax bracket, you can use the full $100,000 to help offset the $200,000 of income. This $100,000 of deductions saves you about $33,000 in taxes if you are treated as a business owner.
— Same facts, but the government treats you as a hobby. This could result in being fully taxed on your $200.000 and probably having your $100,000 of expenses disallowed under the alternative minimum tax. Thus, instead of having the $100,000 of deductions reduce your taxes by $33,000, you end up paying $33,000 more in taxes! Ouch!
NOTE: Some businesses are deemed more suspicious than others . Thus, being a real estate professional, to my knowledge, has never resulted in being treated as a hobby. However, network marketing businesses are deemed suspicious by both the IRS and CRA . Thus, you have to be extra careful.
So what do you do to help ensure that you are a business?
Although there are nine factors used by the courts, the three most important ones usually determine whether the courts will treat a business like a business or like a hobby. Thus, you need to concentrate on these three:
1. Get Proper Documentation
This is CRUCIAL. You need not only a good tax tracker like Taxbot, but also need yearly financial statements. In addition, the courts REALLY want to see a business plan with projections of income and expenses. You can go to an accountant to help you with this or maybe your upline. Again, these items are crucial!
2. Get Expert Advice
The courts want to see people seeking expert advice from successful people or consultants in your industry. This advice needs to be documented and followed by you. If you aren’t making money, for example, you need to meet with your accountant and seek ways to cut back on expenses as much as you can without hindering your business.
NOTE: One Amway court case showed that simply consulting with your upline won’t be good enough. Although I disagree with this decision, it is what it is. Seeking outside experts and/or consulting with several top people in your business would be very important.
3. Show Time and Contacts
It is important to show the time that you put into the business and the names of people that you met. Your tracker and appointment book should be enough to show all this. Time sheets would be ideal for showing the time worked and what you did. However, you do want to show that you are working your business regularly such as at least 45 minutes or so per day , 4-5 days a week. Meeting people and documenting that you are working a few hours each week is very important.
- Have good documentation such as tax tracker and business plan
- Get expert advice from experts and successful people. Don’t just ask your upline, and
- Document the time you work your business with time sheets and the contacts made.
Following the advice in this post can make the difference between eating and living like a king (or at least Trump), or having to constantly scrimp and save. Following the advice in this article will make your life less taxing forever!
(Material derived from my book, “Lower Your Taxes—Big Time”)
P.S. The easiest way to keep good documentation is using our mobile expense tracker TAXBot, especially created for home-based entrepreneurs.
Sandy Botkin, CPA, and former IRS Attorney is the president of the Tax Reduction Institute of Washington DC and lectures all over North America. Sandy was formerly a senior tax specialist with the national accounting firm of Touche Ross (predecessor of Deloitte Touche). Sandy is a bestselling author and has the highest rated tax planning book in the US entitled, Lower Your Taxes—BIG TIME