[NOTE: Quotes below refer to "Schedule C losses". For those who do not know what those are: if an individual has their own business, they file the income and expenses of that business with the IRS using a Schedule C form; losses on that form can then be deducted from their overall income, reducing the amount of taxes they have to pay.]
Internal Revenue Code Section 183 (IRC 183) is sometimes referred to as the “Hobby Loss” part of the code because it deals with the very complex and murky subject of whether a taxpayer is engaging in a profit-driven business that also looks like a hobby or whether they are engaged in a hobby that they are trying to make look like a business in order to deduct costs.
It is so murky because the code is pretty much based on intent (whether a person is trying to make a profit) and--sharp objects aside--an auditor cannot get into the head of a taxpayer. The way tax courts have ruled on this matter has further complicated this matter for both taxpayers and auditors.
By being familiar with IRC 183, though, a person can take steps to make their businesses legitimate in the eyes of the IRS, even if they are taking substantial losses from something that some could argue is just a hobby.
First, a Discussion of the Code
It is worth noting that the code is a work in progress. The first version was created in 1943, in almost direct response to the actions of a man named Marhall Field. At the time, Field was operating two newspapers in Chicago as a sole proprietorship and taking a loss on them on his personal income taxes. Essentially, the Federal government was helping to subsidize his newspapers.
A large amount of litigation followed as the IRS tried to use the code to stop others from reducing their overall tax burden through loss-making side projects. The Tax Reform Act of 1969 was supposed to clarify how much a person could loose before they hand to stop: no more than $25,000 in 3 out of 5 years. A disagreement between the House and the Senate, though, killed putting a dollar amount on losses, resulting in a tax system that “defined profit as not only immediate economic profit but also any reasonably anticipated long term increase…" In other words, the IRS did not have the right to tell someone they were loosing too much money, provided that a profit might be seen at some point in the future.
In order to limit litigation over the now quite subjective rules about profit making, IRC 183 was put into place in 1988. The essential component was that any business which was profitable for 3 years out of a consecutive 5 year period would be considered a business, no matter how much it looked like a hobby. If the IRS wanted to pursue a case, the onus of proving that a business was really a hobby would fall on the IRS.
Today, IRC 183 is considered flawed by the Treasure Department. A recent review stated that “the IRS faces considerable challenges in administrating the tax law for taxpayers who take Schedule C losses year after year for potentially not-for-profit activities.” It said that current regulations “do not establish specific criteria for the IRS to use to determine whether a Schedule C loss is a legitimate business expense without conducting a full examination of an individual's books and records.” A full examination, of course, is a huge drain on IRS resources. According to the report, the IRS experimented with several cheaper methods of recovering money, including sending warning letters (which were often ignored) or doing audits by mail (which turned out to be nearly as time consuming and expensive, and which did not deter most taxpayers from taking losses in subsequent years).
The investigation made it clear that IRC 183 is not a “good tax” because it is so hard to enforce: “we conclude that it is difficult for the IRS to efficiently and effectively administer this provision.”
In its summation, the Treasure Department recommended that the legislation be changed to establish a clearly defined standard or “bright line rule” for determining whether a deduction is legitimate or not.
What the Code Means for Someone Who Turn a Travel Hobby Into a Business
1. According to the guidance the IRS publishes for auditors, “an activity could be considered a for-profit business if a taxpayer shows any profit during a 5 year period, even though larger losses are claimed in the other taxable years.” The safe harbor provided by IRC 183 helps protect the taxpayer. If a business takes three years of profit (which could technically be only a dollar in profit) and two years of heavy losses, the burden of proof still lies on the IRS to prove that it is not a for-profit business. An example of this might be taking a European vacation one summer, taking the cost of the trip as a business loss, and then selling a story ever year for the next three years, generating small profits in those years. The trip was an investment that paid off in the next few years with sold stories (which further your cause of turning your writing into a profitably business). You can do this provided that you “devote time to the business in the honest belief that the business will sometime in the future become profitable."
2. The IRS states: “It is not necessary for the taxpayer to show what their projected profit is expected to be.” Also, the IRS does not have the right to determine whether a business could be profitable, and a “reasonable expectation of profit” is NOT necessary. It is only important that the taxpayer is honestly trying to make a profit.
3. Although the code states that being profitable in 3 years out of 5 should alleviate most suspicion, it still allows a taxpayer to take losses year after year provided they can demonstrate that they are trying to make a profit. In one court case, a taxpayer took $700,000 in losses over seven years and the courts still ruled that he was conducting a for-profit business.
4. IRC 183 provides 9 considerations that an auditor should look at when determining whether a business is for-profit or a hobby loss. Those considerations will be looked in part II of this post.
In Summation
For now, the subjectivity and murkiness of the code is on the side of the taxpayer, particularly if the taxpayer shows three years of profit in a five year period. Provided that the taxpayer is conducting the business in the hopes of making a profit, even if the potential for profit is almost nonexistent, the current law sides with them and allows the loss, even if the loss is quite large and taken year after year after year.
Showing posts with label Travel as Business. Show all posts
Showing posts with label Travel as Business. Show all posts
Tuesday, May 18, 2010
Monday, May 17, 2010
Travel As Business: Assessing the Risks of Taking a Business Loss for Your Travel Business
Turning your travel into a has several benefits, the greatest of which, obviously, is having your job (even it's only your side job) be something that you love. Beyond that, though, it has the benefit of either generating profits for you if the business does well, or generating tax savings for you if the business does poorly .
But taking a business loss on your taxes does have a risk: the IRS determining that you are conducting a hobby and not a profit-driven business and penalizing you for that. And since no one wants to end up in jail while trying to save money on their taxes, here is a blunt discussion of the risks involved in taking a business loss.
If you are audited, an IRS representative will try to determine if your loss is tax evasion or tax avoidance.
Tax Evasion
If you are evading taxes, you are risking a lot of grief. You could be jailed and you could be fined (the amount you owe plus a 75% penalty). If you are found guilty of evading taxes, there is no statute of limitations and and the IRS can look at your entire tax history when trying to assess how much you owe. Obviously, no one wants to be guilty of tax evasion.
Tax Avoidance
Avoiding taxes is another matter. Provided it is legal, you are allowed to avoid as much tax as you can. One way to think about it is if you were to take a longer route home to avoid a toll road. Your effort has allowed you to legally avoid a tax and it was your right to do so.
An IRS agent might disagree with your interpretation of the law, but it is not illegal to take a tax avoidance position that later turns out to be wrong. In this case, the penalty is likely to be the amount you owe, plus 20%.
The statute of limitation on tax avoidance is three years. The IRS cannot recover money from a return filed four years before the audit, even if they determine that on those returns you were incorrectly avoiding taxes.
The Difference
As a CPA once told me: “Mess with the deductions, but never mess with the income.” Lying about income is considered tax evasion. Taking a deduction that the IRS later considers incorrect, though, is usually a case of tax avoidance.
Of course, if you are taking a deduction that you are clearly not entitled to (like taking an education deduction when you obviously weren’t going to school or taking a dependent deduction for kids that you don’t have), then that would almost certainly be considered evasion.
But, as my CPA friend told me, taking a business deduction for an activity that you are making some money on is simply “taking a position. The IRS may later disagree with you, but it was not illegal.”
Chances of Being Audited
Even with Obama’s increase of funding to the IRS, the chances of you being audited if you report less than $100,000 a year is slim. The reason is that when the IRS chooses which cases to persue, they want the potential recovery to make up for the cost of the audit and then some. Most of the cases that are cited when
dealing with hobby-loss are for huge deductions. One was a doctor who tried to deduct his polo playing hobby because he met clients while conducting it. Another was for the owner of a car dealership who was deducting more than $30,000 a year for his stock car racing hobby because he said it helped advertise his dealership. In both cases, the courts disagreed.
If you’re saving yourself $1,000 a year in travel deductions for your travel writing business, it’s hardly worth it for the IRS to spend almost that amount in payroll hours just to get it back.
That said, I firmly believe that you should take deductions as if you were to be audited. Taking Schedule C losses is a red flag for the IRS, even if your deductions are too small to be worth the effort. Individuals also do get randomly selected, and you might get audited for that reason.
While it’s your right to avoid tax by taking business losses for a pleasurable business that you are trying to make a profit from, you should conduct that business as if the IRS will be investigating it. That shouldn't deter you from doing it; it just means that you should be mindful when doing so.
Worth It?
That’s a question only you can answer, but here is a way to think about it: Let’s say you take business loss deductions that net you $1,000 in savings. That’s likely a significant amount of money for you. The chances of you getting audited are slim, but if it does happen and the decision goes against you, you will likely be penalized the amount you owe plus 20%. Since you would have paid the $1,000 if you hadn’t taken the deduction, your loss comes to $200.
That, too, might be significant, but it can help to think of that $200 as an investment. The chances of getting audited if you report $25,000-$50,000 on your tax return are 0.58%. So, would you be willing to invest $200 in a stock if you had a 99.42% chance of turning it into $1200? Even in a casino, it would be a good bet: a 600% instant increase in your pocket with only the smallest chance of you having to give it back later.
Many others have agreed that it's a good bet, which is why Schedule C deductions loose the treasury $1.9 billion a year. Because of this, the Treasury Department recommends fixing the tax code to make it harder to take a business loss for what may appear to be a hobby, but until that happens, taxpayers are allowed to turn their hobbies into businesses as long as they are trying to make a profit from them.
But taking a business loss on your taxes does have a risk: the IRS determining that you are conducting a hobby and not a profit-driven business and penalizing you for that. And since no one wants to end up in jail while trying to save money on their taxes, here is a blunt discussion of the risks involved in taking a business loss.
If you are audited, an IRS representative will try to determine if your loss is tax evasion or tax avoidance.
Tax Evasion
If you are evading taxes, you are risking a lot of grief. You could be jailed and you could be fined (the amount you owe plus a 75% penalty). If you are found guilty of evading taxes, there is no statute of limitations and and the IRS can look at your entire tax history when trying to assess how much you owe. Obviously, no one wants to be guilty of tax evasion.
Tax Avoidance
Avoiding taxes is another matter. Provided it is legal, you are allowed to avoid as much tax as you can. One way to think about it is if you were to take a longer route home to avoid a toll road. Your effort has allowed you to legally avoid a tax and it was your right to do so.
An IRS agent might disagree with your interpretation of the law, but it is not illegal to take a tax avoidance position that later turns out to be wrong. In this case, the penalty is likely to be the amount you owe, plus 20%.
The statute of limitation on tax avoidance is three years. The IRS cannot recover money from a return filed four years before the audit, even if they determine that on those returns you were incorrectly avoiding taxes.
The Difference
As a CPA once told me: “Mess with the deductions, but never mess with the income.” Lying about income is considered tax evasion. Taking a deduction that the IRS later considers incorrect, though, is usually a case of tax avoidance.
Of course, if you are taking a deduction that you are clearly not entitled to (like taking an education deduction when you obviously weren’t going to school or taking a dependent deduction for kids that you don’t have), then that would almost certainly be considered evasion.
But, as my CPA friend told me, taking a business deduction for an activity that you are making some money on is simply “taking a position. The IRS may later disagree with you, but it was not illegal.”
Chances of Being Audited
Even with Obama’s increase of funding to the IRS, the chances of you being audited if you report less than $100,000 a year is slim. The reason is that when the IRS chooses which cases to persue, they want the potential recovery to make up for the cost of the audit and then some. Most of the cases that are cited when
dealing with hobby-loss are for huge deductions. One was a doctor who tried to deduct his polo playing hobby because he met clients while conducting it. Another was for the owner of a car dealership who was deducting more than $30,000 a year for his stock car racing hobby because he said it helped advertise his dealership. In both cases, the courts disagreed.
If you’re saving yourself $1,000 a year in travel deductions for your travel writing business, it’s hardly worth it for the IRS to spend almost that amount in payroll hours just to get it back.
That said, I firmly believe that you should take deductions as if you were to be audited. Taking Schedule C losses is a red flag for the IRS, even if your deductions are too small to be worth the effort. Individuals also do get randomly selected, and you might get audited for that reason.
While it’s your right to avoid tax by taking business losses for a pleasurable business that you are trying to make a profit from, you should conduct that business as if the IRS will be investigating it. That shouldn't deter you from doing it; it just means that you should be mindful when doing so.
Worth It?
That’s a question only you can answer, but here is a way to think about it: Let’s say you take business loss deductions that net you $1,000 in savings. That’s likely a significant amount of money for you. The chances of you getting audited are slim, but if it does happen and the decision goes against you, you will likely be penalized the amount you owe plus 20%. Since you would have paid the $1,000 if you hadn’t taken the deduction, your loss comes to $200.
That, too, might be significant, but it can help to think of that $200 as an investment. The chances of getting audited if you report $25,000-$50,000 on your tax return are 0.58%. So, would you be willing to invest $200 in a stock if you had a 99.42% chance of turning it into $1200? Even in a casino, it would be a good bet: a 600% instant increase in your pocket with only the smallest chance of you having to give it back later.
Many others have agreed that it's a good bet, which is why Schedule C deductions loose the treasury $1.9 billion a year. Because of this, the Treasury Department recommends fixing the tax code to make it harder to take a business loss for what may appear to be a hobby, but until that happens, taxpayers are allowed to turn their hobbies into businesses as long as they are trying to make a profit from them.
Disclaimer: I am not a tax professional, and can not be held liable for losses incurred while following the advice of this website.
Saturday, May 15, 2010
Travel As Business: 47 Travel Websites That Will Publish (and Pay for) Your Travel Writing
You know I love you, right? Which is why I give you this very, very long list of travel websites that accept travel writing submissions. Most pay, even if only a little, and that can let you deduct your travel as a business expense.
HINT: Read their submission guidelines before submitting! Editors routinely toss out stories if they aren't submitted correctly. If you can't get the details straight on sending in a story, how they expect you to have gotten the details straight about travel in a far off country?
ANOTHER HINT: Since I plan on adding more magazines to this post as I find them, I would suggest bookmarking this page and coming back to it periodically.
If you find other online magazines that will publish travel writing, or if there are any problems with any of the links, please leave a comment and I'll add/fix them.
Lastly, if you are published on one of these sites, leave a comment and I will link to your story!
Now go get published!
HINT: Read their submission guidelines before submitting! Editors routinely toss out stories if they aren't submitted correctly. If you can't get the details straight on sending in a story, how they expect you to have gotten the details straight about travel in a far off country?
ANOTHER HINT: Since I plan on adding more magazines to this post as I find them, I would suggest bookmarking this page and coming back to it periodically.
If you find other online magazines that will publish travel writing, or if there are any problems with any of the links, please leave a comment and I'll add/fix them.
Lastly, if you are published on one of these sites, leave a comment and I will link to your story!
Now go get published!
Tuesday, April 6, 2010
Deducting Your Travel on Your Taxes: Overview
NOTE: I am not a tax professional. Although I do deduct my travel as a part of travel-based media producing business, I am not licenced or authorized to give tax advice.
The Idea:
The Idea:
Question: Let's say no one was willing to pay money to hear Lady Gaga's music (not too far fetched: although I like listening to her, I'd stop if it required cash), but she was given the opportunity to perform for for free for 30,000 people. Would she do it? Of course she would, because she loves to sing. No matter how much music stars may gripe about money, there was a time when every single one of them was willing to perform for free. But even if Lady Gaga is not getting paid to do the thing she absolutely loves, she's not working.
It's the same when you're traveling. You love to travel. And maybe you love to write stories about your travel or blog about it. Maybe you love to take pictures and show them to anyone who cares to look. Or maybe you shoot video while on the road and then edit edit it later into movies. You know what you're doing? You're working, even if you're not making a dime.
And that means you can turn your travel into a profit-driven business. You might be able to make quite a lot of money on it, but even if you never turn a profit, the tax deductions alone make it worth it.
Now, before we talk about the specifics, let's talk about both the benefits and the legality of this.
The Benefits:
Firstly, if you have enough money to travel but not enough to disregard its costs, you're probably in the 20-25% tax bracket. Because every dollar you deduct comes from your highest tax bracket, you'll likely be getting $0.25 of that dollar back. If you're deducting your travel, that means you'll be saving 20-25% off your travel expenses. Your $3000 Christmas trip? It now only cost you $2,250. Oh, and the camera you bought for the trip, the new backpack and the clothes? All now 25% off as well.
If you travel a lot or spend a lot traveling, this can be worth thousands of dollars to you.
The Legality:
"Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury." -Judge Learned Hand (Helvering v. Gregory, 1935)
Firstly, this is not a matter of trying to scam the government. If you travel purely for pleasure and produce nothing but memories, than this is not for you.
But if you're someone who spends time make sure your pictures are properly composed and exposed, if you're someone who spends hours editing your videos when you get home, or if you're someone that re-reads a travel blog post four times before publishing it, then you are a media-producing artist. And if you are willing to turn your media-making into a profit-driven business, than you deserve to deduct your travel from your income.
Now, it doesn't matter if you actually make money. It doesn't matter if you spent $5,000 traveling and only earned $10 from the resulting photographs. The IRS can't penalize you for sucking at your business. And it understands that you may invest and loose money for years before you turn a profit because that is what start-up businesses do. It can't penalize you for failure, either. If you spent five years traveling to compile enough stories to write a book that is rejected by a dozen publishers before you finally give up, you are still entitled to deduct every dollar you spent researching that book. That is the beauty of American entrepreneurship.
All this needs on your part is a little organization and a fundamental shift in the way you view your travel. You're not wasting time, you're trying to make a profit. It doesn't matter that you're having fun. In fact, it's awesome that you love your job!
Oh and, before you start worrying about the paperwork, don't. The IRS has done an amazing job of keeping tax forms simple for a small business person like yourself. You won't have to incorporate your business or register it. You will not have to save receipts for your meals and entertainment. The Schedule C-EZ tax form is only a page long, and if you file electronically, you won't even have to bother with that.
The key thing to note is that if you are willing to try and make a profit from your travel, you'll save a ton of money off your travel even if you fail.
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