Differences between Hobby and Business - Essay Example

212232 ANALYSIS As we all are aware, there are many differences between a hobby and business. There is a clear demarcation between the two; but it blurs at times. From the tax angle all the financial activities should be reported from whichever source they are derived, deducting the usual expenses and showing the rest as income. The question here is whether your horse farm falls under the category of HOBBIES or BUSINESS and to do so, it is necessary to understand the difference between the two from the tax standpoint. In a business, all income is reported; but the expenses too are taken into consideration and there are provisions of saving for the future on tax-deductible basis. A profitable hobby, if it remains so, naturally will become a business. This does not mean that a business should always create enormous income and continue to maintain the statuesque year after year. Losses are permitted in every business; but they usually attain the form of a continuous flow where losses the profit are merged. Business is not completely bound by sales, profit or timeframe; nevertheless, the initial recognition of the activity as a business matter a lot for the taxpayer and this recognition is guided by the business logic of making profit, even though it very often fails to reach the expectations. On the contrary, a hobby need not show any profit and can remain a source of pleasure, recreation and fun. Hobby touches the creative and imagination of the person, whereas business is connected with the dry financial gratification1. In a hobby, the person is not answerable to anyone, because it is not a profit-making venture. While "business is any profession, trade, manufacture, or undertaking carried on for pecuniary profit," hobb is is an activity conducted primarily for private pleasure or recreation." http://www.mcleanandco.co.nz/Page115.htm Returning to your horse farm, if losses are continuing every year, beyond a certain business logic, it is not unnatural that IRS, after auditing, placed it under the category of Hobbies. Speaking from the financial/tax point of view, any hope of deducting the expenses would cease here, while the venture remains an expensive and creative activity of self-satisfaction2. Our suggestion is that instead of fighting the case now, it is prudent to wait for the final determination letter and then, armed with all the categorised information, you can start answering the points to resurrect the business angle3. Right now, it is difficult to fathom the grounds on which the categorisation is done, although we can guess; instead, it will be far easier for you to answer the categorisation. To do so, you, as a businessman should be able to show the business path and the convincing hope of attaining such a goal, which will bring the farm into the business-fold. Twenty horses that you maintain on fifty acres of land, and the time that you spend on this farm, especially since your home occupies three acres of the entire land should not be very difficulty to argue that they all fall under the business category. Not having any profit in the last six years, and your statement that you spend only a quarter of your time on the farm, would naturally lead IRS to decide in favour of hobby, denying the full-fledged business status4. In our counter-argument, we shall forcefully argue that hired hands were continuously working on the farm in your absence and considering the situation of your house in the farm, you have spent much more time than a quarter of it, because you lived on the farm and attended to the farm responsibilities at any time according to the need and this includes the emergency, sickness, medical attention etc. that you might have attended to even during the nights and this argument is perfectly acceptable, as IRS knows that livestock need attention beyond working hours. From the profit-making angle, it has to be argued that profit was illusive all these years, because the horses were young and were at the growing stage. Only now, they have started producing colts and hence, will be profitable soon. We are aware that you are financial comfortable enough to face both the situations; but we should rely on this argument to settle this ambiguous status. We also have to argue that many farms were recognised as business, irrespective of profit absence in the initial years. "Unless the facts and circumstances indicate that a taxpayer entered into an activity, or continued the activity with the objective of making a profit, it is technically 'an activity not engaged in for profit' or as it is more commonly referred to, as a hobby," Commerce Clearing House (2005, p.607). Profits keep IRS at bay preventing it from calling the farm a mere hobby. But the recognition of business status will allow you to write off the previous and future losses and the next step after receiving the letter should be convincing IRS that it is a business that traditionally falls under slow-starters and this should be done without giving IRS the feeling that the insistence is merely to deduct the hobby-related expenses and losses and the farm is a mere tax shelter, because deductable expenses and depreciation on purchased assets can change your tax bracket. It is imperative to convince IRS that the horse farm is run by a profit motive and not as fun alone, because hobby expenses deduction is very limited while, business allows to deduct computer, software, stationery, mailing, communication, travel, entertainment, feeding/medical expenses, maintenance, hired hand salaries, transport, home office, etc. and will be to your advantage. Hence, our main thrust should be on the argument that the farm is focussed on the expectation of making money which looks highly possible now with the colts coming and with the house situated on the farm, time segregation is almost impossible. It is very important to convince that the farm is a legitimate business that has taken a longer to prove itself, although not unexpectedly so, because livestock-connected business should be allowed growing, training, showing and maturing margin. For a business argument, it is necessary to establish that it made profit in three years out of five, and this is not possible in your case as there had been no profit. In the absence of profit test, we have to depend upon the factors-and-circumstances test, and have to persuade the agency to take a more individualistic view without presuming that your argument is merely to off-set tax expenditure. Also we will establish that for activities that involve breeding, training or showing of horses, the profit test is two years out of seven even though there again, we are on shaky grounds, because of profit-absence in six years, that might go against you, if not countered effectively. Filing Form 5213 with the IRS can be a good move that will postpone an ultimate decision and gives a breather. It is another way of gaining time to adjust the earlier losses against future profit. Even if you make the profit in the seventh year, it will still fall short of showing two years' profit out of seven and the presentation of your cause should be highly convincing to render the benefit of doubt and hence filing 5213 could help, as we need all possible assistance to pull our argument through. If the profit deludes even in the seventh year, it is important to remember that the deductions would not be allowed and retroactive application of limitations on losses will be an unpleasant blow. Usually, IRS considers each case on its own merit and this means that we might have a better chance of winning5, which should provide you an opportunity to deduct overheads, product manufacturing, capital expenses, product planning and handling expenses etc. from the taxable income, because while hobby is not a taxable activity, business is, but with many fringe benefits. It is necessary to maintain all the records from the business point of view and an insurance cover like Cause-of-Loss insurance, or Business Income Insurance could be of use. "Business cards, a well-maintained set of books, a separate business bank account, current business licenses and permits, and advertising or other marketing efforts will all help to persuade an IRS auditor that your activity really is a business" http://www.immigration-2-usa.com/lawyer-attorney-A25BA1FC-11A6-4AD8-B8E08099DD2967C0.html It is necessary to impress the IRS by convincing them that the time and effort involved indicate a clear profit-making intention and the losses are natural in a horse farm business which is still in its initial phase and future profit is inevitable as the business is reaching its second phase. It is important to reiterate that you possess all the needed business acumen and knowledge and it would be fine if there is a possibility of mentioning any prior experience or connection or even a connected education6. Also we can try to find out of feasibility of using depreciation to show profit. "If you want to succeed in an IRS audit over the hobby loss rule, you must demonstrate that your primary motive is to earn a profit and that you continuously and regularly engage in your business over a substantial period," according to Sim (2005, p. 261). Rapid recognition of any kind of income however trivial it is, and the tax awareness at every step is essential. Just because a person enjoys a hobby, does not mean that he would be a fantastic businessman and it is necessary to evaluate realistically. "Once your hobby becomes your business and livelihood, it may by nature lose the allure it had as a hobby," Schine (2003, p.17). We are sure that you have sufficient chances of winning this argument, and once the categorisation is made, it will not be impossible to ask for a further time beyond the accepted seven years to prove profit. BIBLIOGRAPHY 1. Commerce Clearing House (2005), Federal Tax Course, 2006, CCH, Chicago. 2. Sim, Richard and Guerin, Lisa (2005), Woops! I am in Business! Nolo, Berkley. 3. Schine, Gary L. (2003), How to Succeed as a Lifestyle Entrepreneur running a business without letting it run your life" Dearborn Trade, Chicago. ONLINE SERVICES 1. http://www.mcleanandco.co.nz/Page115.htm 2. Morrisey v. Commissioner (T.C. Summary 2005-86) 3. http://www.immigration-2-usa.com/lawyer-attorney-A25BA1FC-11A6-4AD8-B8E08099DD2967C0.html 4. Read More