Guest Article: Keep Your Home Business a Tax Chomping Machine

So, you finally decided to start your own part-time home business. You have gathered sufficient inventory and equipment to run it. You have a marketing plan of attack to make lots of money, and all you need to do to keep the IRS off your back is save all receipts, right? WRONG!!

One of the IRS's favorite weapons is to treat a home business as a hobby, not as a legitimate business. Even if you have all the receipts in the world, classification of your endeavor as a hobby will limit your "business" deductions to the income from the activity. If the deductions exceed your activity's income, the excess is completely eliminated!

If, however, your endeavor is classified as a business and generates a loss in the first couple of years, you can subsidize your business by reducing the taxes you pay on any other source of income such as your wages, rents, dividends and pensions. You can even even reduce the tax that your spouse would pay on his or her salary. In addition, if your losses exceed your family's income, you can either carryback the loss three years and get a refund from the IRS, or carry it forward 15 years and offset up to the next 15 years of income. Thus, knowing how to maximize the chances your endeavor will be treated as a business makes a difference as to whether your activity survives.

The following example will explain this:
Example: Wayne incurred a $10,000 loss from his part-time business. If he earns $40,000 as an employee, his taxable income for the year will be only $30,000. If, however, the IRS classifies his ''business" as a hobby, he will not be able to use the $10,000 loss and will have to pay tax on the full $40,000.

Thus, the real question is when are you conducting a business vs. a hobby?

The good news is that there is a safe harbor area which, if met, puts the burden of proving your activity is not a business on the IRS. Generally, if you have a profit in three out of five consecutive years, the IRS has the burden of proving your activity constitutes a hobby.

TIP: Once a profit is shown to occur in three out of five consecutive years, the IRS rarely, if ever, challenges the endeavor as a hobby.