TAX ADVICE from Julian Block
tax advisor and Larchmont neighbor, Julian Block, provides
help for Gazette readers
Profits Versus Pleasure: IRS Rules Strict on Losses
Those obliging folks at the IRS allow write-offs to ease
the pain for losses you suffer in ventures entered into make
"profits." But long-standing rules disallow deductions
for losses incurred in pursuing "hobbies."
Because of that distinction, the feds program their computers
to bounce returns that show full-time salaries and other sources
of income offset by losses from sideline undertakings that
turn out to be hobbies -- writing, photography, and painting,
to cite just some of the activities that are likely to draw
the attention of the tax collectors.
How do IRS examiners determine whether your intention is
to turn a business profit from, say, your writing -- or just
to have fun? They get their cues from Internal Revenue Code
Section 183, which provides guidelines on how to distinguish
between a hobby and a business. To take advantage of Section
183, you have to establish a profit motive.
To cut down on disputes, the law presumes that you are engaging
in a business rather than a hobby -- with the IRS as partner
who is entitled to a portion of your profits -- as long as
you have a net profit in any three out of the last five consecutive
years. Net profit is IRS-speak for an excess of receipts over
expenses. (By the way, Congress, in its wisdom, decided that
writers and the like are not as deserving as individuals involved
in the breeding, training, showing, or racing of horses. It
conferred an easier standard on the latter: two out of seven
So, usually, not to worry when you have at least three profitable
years during the last four. Satisfy that stipulation and you
are entitled to fully deduct your expenses this year, even
if this is a loss year.
A QUESTION OF “PROFIT.” What
if you have red ink in more than two out of five years?A much
misunderstood point is that flunking the three-out-of-five
test is not fatal. You still can establish that you conduct
a “for-profit” business, provided you pass an
IRS “facts and circumstances” test.
These are some of the circumstances that the IRS takes into
account in determining your intention to make a profit:
- The way you conduct your writing activities – for
instance, membership in writers’ organizations.
- How much time and effort you expend in the conduct of
your writing career.
The burden of proof to establish that is on you, not the
IRS. To back up your deductions, in the event of an audit,
save such records as queries to publishers and programs from
writers’ conferences. Note, too, that employment full
time in some other field (as is the case with most freelancers)
does not trigger an IRS refusal to classify you as a professional
Your success in carrying on other business endeavors.
The amount of occasional profits, if any, that are earned.
The elements of personal pleasure or recreation.
Your history of income or losses from writing. In particular,
is there a string of losses?
Your activity has to be real work; you cannot use a hobby
that has no income and lots of expenses to offset other income.
If you want to write the Great American Novel and have been
at it 30 years, if there is no income, there are no deductions.
Julian Block is a syndicated columnist, attorney
and former IRS investigator who has been cited by the
New York Times as “a leading tax professional”
and by the Wall Street Journal as an “accomplished
writer on taxes.” His “Year Round Tax Savings”
covers key changes introduced by the 2003 tax act, shows
how to save truly big money on taxes – legally
– and explains the steps you should take to reduce
taxes for this year and even gain a head start for future
Send $9.95 for an e-mailed copy or $14.95 (in the U.S.)
for a postpaid copy to: J. Block, 3 Washington Square,
#1-G, Larchmont, NY 10538-2032. He can be contacted
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