According to a new report by the Government Accountability Office, about 25% of all sole proprietors reported losses in 2006. Most of these business owners used their self-employment loss to offset other taxable income, leading to a significant loss of tax revenue for Uncle Sam.
According to the IRS, approximately 70 percent of those losses were at least partially a result of taxpayers incorrectly applying the tax laws. So how is the IRS going to go after these missing taxes? Two suggested approaches are:
- The IRS could limit the amount that sole proprietor losses could be used to offset other taxable income. While the IRS is concerned that this move could limit the ability to claim legitimate losses, it would certainly limit bogus losses.
- The IRS could go after “hobby” businesses, or those business that are not engaged in for profit. Basically, these businesses have to claim the net sales revenue generated, but are not allowed to claim expenses except as itemized deductions. The IRS seems to be leaning heavily toward this option.
Is your business really a hobby? According to the IRS, if you haven’t made a profit in three of the last five years, then it very well may be! You should be prepared to prove that you’re trying to make a profit and have a legitimate business, not just a money-making hobby.
Deb Howard Greenleaf, EA, CEO and Principal, of Greenleaf Accounting Services provides virtual accounting and bookkeeping services and specializes in financial management to consultants, coaches, solo professionals, and other small business owners across the US. Deb is an Enrolled Agent (EA)—an IRS-licensed tax professional—and specializes in small businesses and entrepreneurs filing Schedule C or as an LLC. As an Advanced Certified QuickBooks ProAdvisor, Deb spends her day in QuickBooks Online and specializes in providing QBO support.