Category: News

Many people dream of turning a hobby into a regular business. Perhaps you enjoy boating and would like to open a charter fishing business. Or maybe you’d like to turn your sewing or photography skills into an income-producing business. You probably won’t have any tax headaches if your new business is profitable over a certain period of time. But what if the new enterprise consistently generates losses (your deductions exceed income) and you claim them on your tax return?

You can generally deduct losses for expenses incurred in a bona fide business. However, the IRS may step in and say the venture is a hobby — an activity not engaged in for profit — rather than a business. Then you’ll be unable to deduct losses. By contrast, if the new enterprise isn’t affected by the hobby loss rules, all otherwise allowable expenses are deductible, generally on Schedule C, even if they exceed income from the enterprise. Important: Before 2018, deductible hobby expenses could be claimed as miscellaneous itemized deductions subject to a 2%-of-AGI “floor.” However, because miscellaneous deductions aren’t allowed from 2018 through 2025, deductible hobby expenses are effectively wiped out from 2018 through 2025.

How to NOT be deemed a hobby:

There are two ways to avoid the hobby loss rules: Show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing or racing horses). Run the venture in such a way as to show that you intend to turn it into a profit maker rather than a mere hobby. The IRS regs themselves say that the hobby loss rules won’t apply if the facts and circumstances show that you have a profit-making objective. How can you prove you have a profit-making objective? You should operate the venture in a businesslike manner.

The IRS and the courts will look at the following factors: How you run the activity, Your expertise in the area (and your advisors’ expertise), The time and effort you expend in the enterprise, Whether there’s an expectation that the assets used in the activity will rise in value, your success in carrying on other activities, your history of income or loss in the activity, the amount of any occasional profits earned, your financial status, and whether the activity involves elements of personal pleasure or recreation. Case illustrates the issues in one court case, partners operated a farm that bought, sold, bred and raced standardbred horses. It didn’t qualify as an activity engaged in for profit, according to a U.S. Appeals Court. The court noted that the partnership had a substantial loss history and paid for personal expenses. Also, the taxpayers kept inaccurate records, had no business plan, earned significant income from other sources and derived personal pleasure from the activity. (Skolnick, CA 3, 3/8/23)

Contact us for more details on whether a venture of yours may be affected by the hobby loss rules, and what you should do to avoid tax problems. © 2024

It’s not unusual for a partner to incur expenses related to the partnership’s business. This is especially likely to occur in service partnerships such as an architecture or law firm. For example, partners in service partnerships may incur business expenses in developing new client relationships. They may also incur expenses for: transportation to get to and from client meetings, professional publications, continuing education and home office.

What’s the tax treatment of such expenses?

Here are the answers. Reimbursable or not as long as the expenses are the type a partner is expected to pay without reimbursement under the partnership agreement or firm policy (written or unwritten), the partner can deduct the expenses on Schedule E of Form 1040. Conversely, a partner can’t deduct expenses if the partnership would have honored a request for reimbursement. A partner’s unreimbursed partnership business expenses should also generally be included as deductions in arriving at the partner’s net income from self-employment on Schedule SE.

For example, let’s say you’re a partner in a local architecture firm. Under the firm’s partnership agreement, partners are expected to bear the costs of soliciting potential new business except in unusual cases where attracting a large potential new client is deemed to be a firm-wide goal. In attempting to attract new clients this year, you spend $4,500 of your own money on meal expenses. You receive no reimbursement from the firm. On your Schedule E, you should report a deductible item of $2,250 (50% of $4,500). You should also include the $2,250 as a deduction in calculating your net self-employment income on Schedule SE. So far, so good, but here’s the issue: a partner can’t deduct expenses if they could have been reimbursed by the firm. In other words, no deduction is allowed for “voluntary” out-of-pocket expenses.

The best way to eliminate any doubt about the proper tax treatment of unreimbursed partnership expenses is to install a written firm policy that clearly states what will and won’t be reimbursed. That way, the partners can deduct their unreimbursed firm-related business expenses without any problems from the IRS. Office in a partner’s home subject to the normal deduction limits under the home office rules, a partner can deduct expenses allocable to the regular and exclusive use of a home office for partnership business. The partner’s deductible home office expenses should be reported on Schedule E in the same fashion as other unreimbursed partnership expenses.

If a partner has a deductible home office, the Schedule E home office deduction can deliver multiple tax-saving benefits because it’s effectively deducted for both federal income tax and self-employment tax purposes. In addition, if the partner’s deductible home office qualifies as a principal place of business, commuting mileage from the home office to partnership business temporary work locations (such as client sites) and partnership permanent work locations (such as the partnership’s official office) count as business mileage.

The principal place of business test can be passed in two ways:

First, the partner can conduct most of partnership income-earning activities in the home office. Second, the partner can pass the principal place of business test if he or she: Uses the home office to conduct partnership administrative and management tasks and doesn’t make substantial use of any other fixed location (such as the partnership’s official office) for such administrative and management tasks.

To sum up when a partner can be reimbursed for business expenses under a partnership agreement or standard operating procedures, the partner should turn them in. Otherwise, the partner can’t deduct the expenses. On the partnership side of the deal, the business should set forth a written firm policy that clearly states what will and won’t be reimbursed, including home office expenses if applicable. This applies equally to members of LLCs that are treated as partnerships for federal tax purposes because those members count as partners under tax law. © 2024

Operational changes

Effective January 2, 2024, ATA CPAs + Advisors PLLC entered into a new operating structure called an alternative practice structure. As part of that restructuring, ATA CPAs + Advisors PLLC has transferred all of its nonattest business and engagements as well as all employees to a new company called ATA Advisory, LLC. All attest and assurance work will remain in the current entity that will be renamed ATA, PLLC. The two entities will operate under the jointly marketed name “ATA” going forward.

What this means

ATA, PLLC will remain a licensed CPA firm that provides attest services; ATA Advisory, LLC and its subsidiary entities will provide tax and advisory services and not operate as a licensed CPA firm. All partners with ATA, PLLC will also be partners with ATA Advisory, LLC. All current staff will be employed by ATA Advisory, LLC under this agreement.

As part of this arrangement, ATA, PLLC and ATA Advisory, LLC will enter into an administrative services agreement. Within the operations of the alternative practice structure, and under the administrative services agreement, ATA, PLLC will lease professional and administrative staff from ATA Advisory, LLC to support ATA, PLLC’s performance of audit and attest engagements.  The employees leased from ATA Advisory will be under the supervision of ATA, PLLC when they are working on ATA, PLLC assurance engagements.

ATA Advisory, LLC will maintain custody of all files for clients of both ATA, PLLC and ATA Advisory, LLC. Both companies will comply with the same confidentiality obligations with respect to your confidential information. Please let us know immediately if you have any objections to the transfer of your files between the two entities.

What to expect 

Ultimately, you should expect to interact with the same partners and associates within ATA. Operationally, the alternative practice structure will allow us to provide improved service offerings to better serve our clients.

If you have questions, don’t hesitate to contact the partner with whom you have an established relationship.