Two buddies met in a bar. Over a few drinks they talked about how much they contributed to their employers and how little they were paid for their efforts. After few drinks they decided to start their own business. They thought that, since they are such good friends, they would skip the formalities and proceed based on their oral agreement. They did formalize a couple of things. They form an Idaho LLC because one of them heard that an LLC provides protection. When they tried to open a business bank account, they discovered they needed a Federal Tax ID Number, so they took care of that. They initially agreed that one was to provide the equipment and know-how and the other would fund the start-up costs and do the marketing.

A few months later there was money coming in but they were struggling with paying the business expenses and paying themselves. In order to meet living expenses, one of them had to take out a second mortgage and the other had to take a second job.

Struggling to make the business grow and make a living at the same time, these two fast friends began to argue. Fifteen months after they met in the bar, they decided to dissolve the business.

However, it wasn’t over. They soon learned that there were a number of legalities in running a business that cannot be ignored. Government agencies began calling about such things as tax permits, workers compensation, unemployment insurance, payroll tax and the like. Neither knew what to do about that and because they are barely speaking to each other, how in the world could they get this all worked out?

While this is story is fictional, some business owners may ruefully recognize parts of it. Unfortunately, there is no “rewind” or “undo” button to allow us to go back and start over.

So, where did our partners go wrong? They assumed that because they were good friends, they would always agree on things or at least be able to work them out. However, they would have avoided many problems had they documented the partnership with an agreement that:
• Lays out each partner’s responsibility;
• Specifies what each partner will contribute in terms of money, tools and equipment, expertise;
• How much of the business belongs to each partner;
• What happens if one partner wants to quit or dies; and
• What happens if the business doesn’t make a profit?

Creating a partnership agreement can prevent the problems these “buddies” faced. You can do this by visiting an attorney, or we have even seen well-written agreements for a simple LLC prepared on a legal website.

Then visit us at Ada Tax Professionals where we can help set up your bookkeeping properly. We can also refer you to other resources. To quote an old adage… Don’t forget to cross your t’s and dot your i’s. In other words, start with a plan, add the details and then go for it.

 

Business: An activity pursued with the objective to make a profit

Hobby: A revenue producing activity pursued for pleasure and lacking a profit motive

 

In your eyes which type of activity is yours?

 

How is each treated for tax purposes?

 

Business:

If you have a business, you are allowed to offset your revenue with all ordinary and necessary business expenses.  Should you experience a loss, you can offset other income.  A profit is subject to income tax and self-employment tax. In addition, certain other tax benefits may apply.

 

Hobby:

All income is reportable and only the direct cost in any product sold is an allowable expense. Hobby income is not subject to self-employment tax.  Activities such as the sale of your arts/crafts or activities for sport or recreation are often not entered into for profit.

 

Audit Danger:

If the activity is reported as a business and experiences several years of loss, IRS may audit you to determine if you have a profit motive. If the loss is disallowed you will owe tax, interest and penalties. Here are several factors they take into consideration.

 

Among the factors to consider are whether:

  • You carry on the activity in a businesslike manner,
  • The time and effort you put into the activity indicate you intend to make it profitable,
  • You depend on the income for your livelihood. Your losses are due to circumstances beyond your control (or are normal in the start­up phase of your type of business)
  • You change your methods of operation in an attempt to improve profitability,
  • You were successful in making a profit in similar activities in the past, The activity makes a profit in some years,
  • You can expect to make a future profit from the appreciation of the assets used in the activity.

 

Some suggestions to prove your profit motivation:

  • Keep thorough and businesslike books.
  • Log your daily hours spent on the activity
  • Use a separate business checking and credit card
  • Record business and personal use of assets in a log book
  • Research market/technology trends used in similar businesses
  • Obtain the insurance, registration, certification, license, etc needed for the business
  • Document periodic evaluations of operations to attempt to improve business’s profitability
  • Develop a written business plan and update it annually

 

Regardless of how you would like to treat your activity for tax purposes, will you be able to argue your position with the IRS?

Social Security benefit statements (tax form 1099-SSA) have started to show up in mailboxes.  These are the familiar mailers with the ‘pink boxes’ that all Social Security recipients get each January.

Same goes for military pension statements (tax form 1099-R) sent from DFAS.  They are available now online.

Despite the current government shutdown, the 2019 tax season begins as usual.  The IRS is accepting business returns as of last week (Jan 8th).  Processing of individual returns will begin Monday January 28th.

IRS offices remain closed and phones are answered with recordings that say “Live phone assistance is not available at this time.  Normal operation will resume as soon as possible”.

We’re joining the IRS in encouraging everyone to check the tax withholding on paychecks, pensions and other forms of income.  There was a huge change this past spring when the new withholding tables became effective as part of the new tax law.  

Call our office, 208-377-4303, to make an appointment for a mid-year check up.

You can also use the withholding calculator on the IRS website.  Look for ‘Do a paycheck Checkup’ section on their homepage, irs.gov.