I have a side business teaching archery. I had to file as a loss due to expenses for the first two years, with notable increase in income and customers this last year. But I'm still coming out at a loss, albeit a much smaller one than previously. I'm aware that I have to show 3/5 years of profit to avoid being reclassified as a hobby, but this is how things turned out sadly.
Do I cut back on reported expenses to show a profit, or can I show a loss and prepare to show all my effort and receipts if ever audited? I am truly trying to make this come out ahead with a new website and campaign in the works, this is not a hobby.
Third year of small business taking a loss: Show a 'profit' or file as is?
byu/Highwayman1717 intax
Posted by Highwayman1717
7 Comments
>I have to show 3/5 years of profit to avoid being reclassified as a hobby
You don’t **have** to show that. 3 out of 5 profitable years merely gives you the presumption of a profit motive.
The IRS looks at a range of factors to consider whether your business should be reclassified as hobby income:
[https://www.irs.gov/newsroom/know-the-difference-between-a-hobby-and-a-business](https://www.irs.gov/newsroom/know-the-difference-between-a-hobby-and-a-business)
Don’t falsify your business expenses. File accurately, document your efforts and keep receipts, read the above and related links, and in the unlikely event of an audit you can still demonstrate your profit motive.
You are required to file a complete and accurate tax return. If an accurate tax return reflects a loss, then it is a loss.
If you were to report something other than what the actual case is, then you can’t reasonably sign the tax return under penalty of perjury that it is true and accurate since you know something is not correct on the return.
Report the true events.
Do you think that filing a false return would turn a “hobby” into a “business” or just turn you into a criminal?
You are applying the 3/5 year profit safe harbor incorrectly. Plenty of legitimate businesses lose money for years and yet there is no question they are businesses and not hobbies.
Evaluate your business along these guidelines:
1. The taxpayer carries out activity in a businesslike manner and maintains complete and accurate books and records.
2. The taxpayer puts time and effort into the activity to show they intend to make it profitable.
3. The taxpayer depends on income from the activity for their livelihood.
4. The taxpayer has personal motives for carrying out the activity such as general enjoyment or relaxation.
5. The taxpayer has enough income from other sources to fund the activity
6. Losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
7. There is a change to methods of operation to improve profitability.
8. Taxpayer and their advisor have the knowledge needed to carry out the activity as a successful business.
9. The taxpayer was successful in making a profit in similar activities in the past.
10. Activity makes a profit in some years and how much profit it makes.
11. The taxpayer can expect to make a future profit from the appreciation of the assets used in the activity.
[https://www.irs.gov/newsroom/heres-how-to-tell-the-difference-between-a-hobby-and-a-business-for-tax-purposes](https://www.irs.gov/newsroom/heres-how-to-tell-the-difference-between-a-hobby-and-a-business-for-tax-purposes)
3 and 4 are usually the problems. I am guessing that you have another job that actually pays the bills, and I am also guessing that you enjoy archery and would probably be doing it for recreation even if you weren’t coaching.
Try to make the other indicators out weigh those two.
File an accurate tax return. You’re signing it under penalties of perjury. The fact that the amount of your loss is getting smaller and you’re hopefully on track to start turning a profit is good. There’s a lot more to the business/hobby analysis than just looking at whether it turns a profit in 3 out of 5 years. Study up on it a bit.
The fact that it’s a side gig is not a good fact, as the IRS could argue you aren’t doing everything you can do to try to make it profitable and you’re instead doing it because you enjoy archery and just want to make some extra money while you’re doing it.
What kind of expenses are you deducting that you are considering leaving off?
Are you backing out any deduction for personal use of items?
just file it as is, save your receipts, and hope for the best. if you get audited, show them you’re serious about the business.
If there are expenses which are kinda borderline like say that new bow or the cool targets I’d leave those off and file a return where you made $500. The IRS will leave you alone.