Keep Your Small Business Advantage!
While your know-how is certain to make an important difference in your business’ success, you’re no doubt well aware that producing a winning combination for a smooth-running operation depends on many other factors as well.
High on the list of considerations for your business should be creating the ability to meet criteria imposed by Uncle Sam and the Internal Revenue Service. To help you avoid headaches that can go with trying to meet tax law requirements, this brochure highlights pitfalls to be aware of and provides some tips on how to overcome them.
“Material Participation” In Your Business
“Material participation” has become a major issue for business people since Congress passed rules regarding “passive activities” in the late ‘80s. To show material participation, you as the owner must demonstrate that your activity in your business is continuous and substantial. The IRS has established several “tests” for measuring material participation. An owner who can’t pass any one of the tests will most likely be considered just a passive investor in a company. Since deductible losses from passive activities can be limited to the amount of income from such activities, showing material participation in your business becomes doubly important.
If you work full-time in your business, you will have no trouble showing you materially participate. However, if you’re an employee at another job and operate your business on a part-time basis, you need to make sure you pass one of the material participation tests. One way you can do this is to show that you spend 500 or more hours during the year running your business. You can establish material participation in other ways too – e.g., based on your past years’ involvement or how your work time compares with others working in the business (including employees).
Your Profit Motive
The IRS sometimes questions profit motive of a business owner if an activity consistently shows tax losses. This is common with activities that lend themselves to personal enjoyment or hobby such as horse/dog breeding, arts and crafts, etc. You should be prepared to show that you entered your business with the intent to make a profit and that you are taking measures to realize that intent. How do you show profit motive? At least in part by establishing that you have expertise in your field and you are using businesslike practices in carrying on operations.
Your Recordkeeping Routine:
The recordkeeping system: Give priority to establishing good recordkeeping practices for your business. Recordkeeping goes much farther than actual check writing, depositing income, keeping receipts, etc. Also involved are the choices you must make about accounting methods, dealing with inventory (if any) and other assets, complying with regulatory and tax requirements, and technology. You will probably find taking care of all these details time-consuming and frustrating to say the least; many of the choices you have to make may require help from a financial or accounting professional.
When keeping your business records, though, try to follow a few basic “rules”:
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