KENNETH TURNER ASSOCIATES
The Ultimate Tax Shelter: Owning Your Own Business
By Jeff Schnepper
The No. 1 way to reduce your taxes is to convert your personal expenditures into allowable deductions. Turn yourself into a business owner and cut your taxes.
It is almost that simple.
This column will explore what I call the ultimate tax strategy --that of converting personal expenses into legitimate business expenses. To win this game, you must own your own business.
Establishing A Profit Motive Is The Key
To be in business, you merely declare it. And by doing so, you can magically turn personal expenses into tax deductions. If you want to operate in a noncorporate format, as an individual proprietorship, but under a different name than your own, no problem.
Here is the best part: Your business does not have to make a profit for your expenses to be deductible. All you have to do is establish a profit motive. Under the Internal Revenue Code, a profit motive is presumed if you earn any net income in any three out of five business years.
It is recognized and expected that new businesses probably would not make a profit in the early years. In fact, in the early years, you can insist that the IRS defer any challenge for the first five years as to the legitimacy of your business by filing Form 5213.
Remember you do not have to show a profit -- just a profit motive. In one case, despite 20 years of losses, the court found a profit objective and allowed the deduction of business losses in full for one company. The case was not unusual.
The test for deductibility is whether you have an actual and honest profit objective. You need not have a reasonable expectation of a profit. While the Tax Court requires a primary or dominant profit motive, the U.S. Claims Court has held that having a reasonable chance to make a profit, apart from tax considerations, will suffice.
The test is subjective: Was your intent to earn a profit? The IRS looks at the following factors to decide if your intentions are honorable:
1. The manner in which you carry on the activity;
2. Your expertise and the expertise of your advisers;
3. The time and effort you expend in carrying out this activity;
4. The expectation that the assets used in your business may appreciate in value;
5. Your success in carrying on similar or dissimilar activities;
6. Your history of income and losses with respect to the activity;
7. The amount of occasional profits, if any, that are earned;
8. Your financial status;
9. The elements of personal pleasure and recreation. That does not mean that just because you enjoy doing your job that the expenses are not tax-deductible. The Tax Court has ruled that suffering has never been made a prerequisite for deductibility.
Moreover, even if you are employed full time elsewhere, that does not prevent you from having another vocation on the side. This technique works whether your business is your primary source of income or it is a sideline.
How To Qualify As A Business Deduction
To qualify as business deductions, your expenses must be:
1. Ordinary and necessary -- defined by the courts and the IRS as reasonable and customary,
2. Paid or incurred during the taxable year, and
3. Connected with the conduct of a trade or business.
The term reasonable and customary depends on your specific business and the business customs in your locale. The expenses do not have to necessarily be reasonable and customary to you, but simply to your particular trade or industry. There are innumerable cases of hobbies converted into businesses with expenses allowed.
Focus on your profit-making motive. Remember that it is not what you pay in taxes that counts, it is what you keep.
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Copyright © 2001 Kenneth C. Turner. All Rights Reserved