This is a great article regarding a key qualification for taking your business expenses as tax deductions (Hint: It has to do with whether you are treating it as a hobby or a business).

I have included the entire article here.

“Home-based MLM businesses are growing at an accelerated rate due to layoffs, downsizing, mergers, and the need for second family incomes. What many entrepreneurs are missing out on and need to know is that there are allowable tax deductions that may reduce their gross income, thus significantly lowering what they owe Uncle Sam at the end of the year. This is great news! However, it comes with a word of warning. While you might enjoy some big benefits at tax time through deductions, the IRS has some very specific rules as to what it deems to be a hobby vs. a legitimate business expense. It’s essential that you study up to make sure you aren’t playing “audit roulette”!

With the rise in home-based MLM businesses, the IRS is taking a closer look to see if an operation is actually a business or a hobby. If you have a business, you can take losses associated with it as a deduction on your tax return. However, you are not allowed to deduct losses involved with hobbies. The best way to prove you have a business is to have net income, but that isn’t always possible. So, if you find you have losses, make sure to document in detail your business intent as well as your time and effort expended through business meals, mileage, office and promotional supply receipts etc. You don’t want the IRS to disallow your losses because they say your business is a hobby and not a real business.

Once you’ve established that your operation indeed qualifies as a business, then there are definitions of legitimate business deductions. Although every business is different, a broad definition presented in Stephen Fishman’s book, Home Business Tax Deductions: Keep What You Earn, is: “Every tax deduction has to be reasonable and necessary, and directly related to business.” But, then there are the details, and one detail not to be overlooked is the question, “What is a legitimate deduction and what is not?”

Another equally important detail, as some entrepreneurs have learned only after the tax man has “come a knockin’ on their door,” is to keep accurate records of your qualifying expenses, then consult with and file your taxes using a knowledgeable and qualified tax consultant.

It really is better to be safe (informed and prepared) than sorry, as is illustrated in the case of Brenda Konchar, a Mary Kay representative, who filed her taxes, claiming items as business deductions. To her misfortune, the IRS disagreed because she claimed deductions that exceeded her income. She took her case to the tax court and lost with the court concluding that her deductions exceeded her income, and disallowed the losses. They stated that her pursuit was just a hobby, not a business and that even if she had had what they considered a business, her expenses were not legitimate business expenses.

Some statistics show that small or home based business owners are three times more likely to be audited than traditional business owners. “But that isn’t necessarily true,” says Jan Zobel, author of Minding Her Own Business: The Self-Employed Woman’s Guide to Taxes and Recordkeeping. “I don’t agree that chances of getting audited are greater with a home-based business.” The key is to use the term, “home office” the same way the IRS does.

In reality, your chances of being audited are about 1%. You’re not at a greater risk of being audited if you prepare your return in ink vs. a computer generated return. It also doesn’t raise red flags if you were the first to file your return or if you filed it a month after the deadline. Most returns are audited because of their Discriminate Function (DIF) score, a technique that compares your return’s income and deductions, against national averages.

To learn exactly what the IRS is looking for and to fall within a safe DIF score, you can visit the IRS website and see what deductions apply specifically to your type of home-based business and what documentation you are required to keep. The IRS website provides helpful, comprehensive information for small businesses. It lists a toll-free number in case you need more help with necessary forms and tools.

Another great resource is the Office of Advocacy of the U.S. Small Business Administration (SBA) website at Small Business Advocacy. Created by Congress in 1976, the SBA is an independent voice for small business within the federal government. There are also a myriad of great books and resources out there with even more information if you do a little “Googling”.

You will find it well worth the effort to do a little of your own research, then find a qualified tax consultant who can tell you specifically what receipts and other records to keep so you can avoid the headaches and pitfalls when tax time comes around. Again, the most important thing you can possibly do is to keep detailed records throughout the year!

Running a home-based business offers some great tax advantages that other businesses cannot claim. Unfortunately, many business owners are not aware of the benefits available to them. So, do a little leg work to make sure you fall within the IRS home-based business guidelines and then take every legal deduction available to you!”

So, as you can see, spending a little extra time to educate yourself on what is and isn’t acceptable to the IRS can save you a big headache and a lot of money.

http://www.mlm.com/mlm/user/mlmarticle/1671/A+Hobby+or+a+Business--Don%27t+Play+%3FAudit+Roulette%3F+%28Part+1%29+by+Brenda+Clemons.html

Tags: Audit, Business, Tax