If your business goes too many years without making a profit, it can be classified as a hobby. When it becomes a hobby, you can no longer claim losses as business deductions. Any expenses associated with your business in an effort to make a profit may be deducted.
In order to determine if you are running a business or a growing hobby, the Internal Revenue Service (IRS) looks at the following qualifications:
Do you put in the time to turn a profit?
Have you made a profit in the past?
Do you have the necessary knowledge to succeed in your field?
Do you depend on the income from this activity?
Were your losses beyond your control?
If your business doesn’t turn a profit for 3 out of 5 years (except in specific industries, like horse racing) then it is classified as a hobby, according to the hobby loss rule, and you can no longer claim tax deductions against other revenue.
If you want to reverse the IRS’s decision about your business, then you have to prove your intention was to make a profit. Keep extensive files showing where you spent your money and how it was imperative to your business.
If you try to claim your hobby as a business then it could trigger an IRS audit. Only claim deductions if you are actually running a business. For more clarification on what constitutes a business or a hobby, the IRS has put out a helpful guide you may want to read.
Who Does the Hobby Loss Apply To?
The hobby loss rules work to prevent any hobbyists from taking advantage of the tax benefits of businesses. Business entities that the Hobby Loss Rule applies to are S-corporations, individual business owners, business estates, and partnerships. Most companies that possess the responsibilities for any liabilities incurred by the business that land on the owner of the business can be affected by the Hobby Loss Rule. C-corporations are exempt from the Hobby Loss Rule because of the adjusted gross income threshold of 2 percent for C-corporations.
Hobby Loss Rule Scenario: When Does the IRS Consider Your Business a Hobby?
To better illustrate the impact of the hobby loss rule, I have a scenario that many of our clients can relate to.
Janet is the blogger and owner of a lifestyle blog. She’s been blogging for 5 years. Over those years she’s claimed her blog as a business on her taxes. The first 2 years she did not make a profit. The third and fourth years she did bring in some money from her blog. This year Janet is hoping to make a profit again so that her blog isn’t classified as a hobby.
Janet’s blogging expenses for her fifth year in business were:
Website hosting
Website domain
WordPress theme
Purchased ad space on other blogs
Blogging conference tickets and travel expenses
3 online courses
Photoshop subscription
Janet brought in money from the following avenues:
Selling ad space on her blog
Several sponsored campaigns
Paid social media posts
Unfortunately, Janet’s expenses outweighed her income and she reported another loss. According to the hobby loss rule, her blog is now considered a hobby, not a business.
Janet still wants to run her blog like a business. She is going to try to prove that she ran her blog with the intent to make a profit. Janet will show that she intended to make a profit by attending a conference to increase her knowledge. She also kept strict records showing her business expenses. She can submit these to try and still claim her deductions.
The IRS will have to determine if Janet’s blog can still be considered a business, but her careful records will benefit her in making a case.
Prevent Your Business from Becoming a Hobby
If you are an owner of a newly established business, keep track of your business plans, receipts, and records. While we all hope to start turning a profit after the first few years in business, life can be unpredictable. Having these records in place can help you make your case that your business is a legitimate business, and you deserve the benefits that come with it.
If you need help with your business taxes or finances, reach out to our team. We specialize in helping small business owners save time, money, and stress on their taxes and accounting.
As a small business owner, there are many decisions you will need to make many decisions that will impact your company for years to come.
Among these decisions is which corporate entity is best for your business. In this blog, we will review 5 different types of business entities (single and multi-member LLC, C Corp, S Corp, Partnership, Sole Proprietorship) along with their advantages and disadvantages so you can decide which works best for your business.
Sole Proprietorship
Many small business owners form a sole proprietorship when they’re just starting out.
If you are a sole proprietor, this means that you own and operate your business by yourself. You have complete control. All the profits of your business are yours.
However, with a sole proprietorship, you have no liability protection, which means you are responsible for all losses and debts as well. If any legal issues arise, you will be held personally responsible and those debts will need to be paid from your personal account.
A sole proprietorship is one of the simplest and least expensive entities to form because no legal paperwork is needed. However, your city or state may require you to obtain a business license, so be sure to look into the requirements for your specific state. In addition, you will want to register your business name with your state.
When it comes to your business taxes, filing is quick and easy. You can file your business taxes with your personal taxes using a Schedule C form.
In addition, you can deduct expenses and losses from your business against any other income you might earn, which will lower your tax bill overall.
The one drawback about taxes for a sole proprietor is that you are expected to pay a 15% self-employment tax on all your net income, which covers Social Security and Medicare taxes.
You are also required to pay estimated quarterly taxes throughout the year. These payments are usually due April 15, June 15, September 15, and January 15. If you fail to pay estimated taxes quarterly, you may have to pay a penalty and interest on what you owe.
Overall, the advantages to forming a sole proprietorship are that it is the least expensive entity to form, you have complete control of your business, and tax preparation is quick and easy.
The biggest disadvantage is no liability protection.
General Partnership
A general partnership is simple to form. Like a sole proprietorship, your city or state may require you to obtain a business license, and you will want to register your business name with your state.
I’d also strongly recommend that you set up an operating agreement for your partnership. What are the roles and responsibilities of each partner involved? What percentage of the profits will you share? Determining this at the start will benefit your business as you get up and operating.
Like a sole proprietorship, a general partnership does not give you liability protection. This means each partner in the business is personally responsible for any debts or legal action.
General partnerships are also required to pay the 15% self-employment tax on all their net income as well as quarterly estimated taxes. However, as a partnership, you have a lot of flexibility and can deduct any losses in your business against other income to lower your taxes.
That’s where the similarities between a general partnership and a sole proprietorship end. Partnerships add more complexity because there are multiple owners involved.
In a partnership, you will file a partnership tax return every year on Form 1065. Then, each partner is given a Schedule K-1 showing their individual share of the profits and losses, based on your agreement. That means you will need to file a form as a partnership as well as the Schedule K-1 as part of your personal tax return.
Single Member LLC vs Multi Member LLC
The main two types of LLCs are single member LLC and multi member llc. Comparing single member LLc vs multi member LLC, you want to account for how many owners are involved in the business. More of the similarities and differences between these two business structures are discussed below.
Single-Member LLC
A limited liability corporation, or LLC, is more expensive to form than a sole proprietorship.
An LLC must be registered in the state where it does business. Each state varies slightly, but most require you to choose a distinct name and to file articles of organization. These articles of organization include information like your business name, address, and the names of its members. Many states charge a filing fee for the articles of organization. For most states, you file with the Secretary of State; however, each state is different, so carefully check the requirements in your state.
Unlike a sole proprietorship, an LLC offers liability protection, which means your business assets are separated from your personal assets. So, if your business is sued or runs into financial trouble, the business will be responsible for paying any fees, not you personally.
In addition, with a single-member LLC, you have complete control and flexibility. All the profits of the business are yours, and you can deduct any losses in your business against other income to lower your tax bill.
However, like a sole proprietorship and partnership, you will be required to pay self-employment tax on all of your net income to cover Social Security and Medicare taxes, unless you elect to be taxed as an S corporation. You are also required to make estimated quarterly tax payments.
As a single-member LLC, you can elect to be taxed as a sole proprietorship or as an S corporation, which we will discuss in more detail below.
Multi-Member LLC
A multi-member LLC shares many similarities with a single-member LLC. For example, you get the same liability protection. You also go through the same formation process and file documents with your state. And you can elect to be taxed as an S corporation.
The main differences between a single-member and multi-member LLC revolve around the fact that multiple business owners are involved. Because of this, you can not elect to be taxed as a sole proprietorship. Your LLC will need to file a business tax form and each partner will need to fill out a Schedule E on their personal tax return, unless you elect to be taxed as an S corp, which we will discuss below.
In addition, some complexities arise with sharing control of the business, which is why you will want to have an operating agreement in place.
S Corporation
S corps have the benefits of a corporation but are taxed as a partnership. Like an LLC, an S corp separates business owners and their assets from the business. Creditors can only go after the business but can’t touch the business owner’s assets.
However, establishing an S corp takes more leg work and paperwork than an LLC. Most S corps spend a considerable amount on attorney and accounting fees.
An S corp also requires more maintenance. For example, to be an S corp, you must develop a board and bylaws, issue stock, hold board meetings, and keep records of each board meeting.
In addition, the IRS also has the following requirements for S corps: 1) shareholders must be US citizens, 2) you cannot have more than 100 shareholders (spouses count as separate shareholders), and 3) you can only have one class of stock.
The taxation of an S corp is what sets it apart from other business entities. When you have an S corp, your business is taxed through the shareholders’ income, and those taxes are taken out throughout the year.
Any shareholder who works for the company must be paid a reasonable wage. After the wages are paid, the rest of the income from the business is passed onto the shareholders as dividends. The benefit of an S corp is that dividends are taxed at a low rate if they are taxed at all. An LLC taxed as an S corp can also take advantage of these benefits.
To take advantage of these tax benefits, you are required to set up payroll for your owners and employees. The laws for S corps are not the same in each state, so you will want to look into individual requirements for your state.
C Corporation
Unlike an S corp, a C corporation protects the small business owner or owners by acting as a fiduciary barrier between the income a business brings in and the progenitors and stakeholders responsible for its operations as executives.
While S corps are considered “flow-through” entities, C corps are not. C corps exist separately as a taxable party in the eyes of the government. This “double taxation” notion is the key reason many small business owners opt to establish themselves as LLCs or S corps instead.
The decision between LLC vs. S corp vs. C corp vs. partnership is often fraught with pitfalls. While many publicly-traded companies are C corps on the books, this classification is typically only chosen by those with the means to dodge double taxation at the end of the year. Two common examples are lawyers at the helm of their own firms and doctors in private practice.
So, which entity works best for your business?
Unfortunately, there is no simple answer. Depending on your business, industry, structure, and revenue, different benefits might outweigh some of the disadvantages.
In addition, what entity works best for your business might change as your business grows. So the best advice I can provide is to know these pros and cons. Then, as the complexity of your business increases, seek the advice of experts who can analyze what works best for your situation. Paying extra for expert insights now can have significant payoffs in the long run.
If you want customized insights into your business, reach out to our team! We would love to help. We specialize in small business accounting, bookkeeping, and taxes, and we enjoy having ongoing discussions with our clients to help them make decisions that will lead to their business success.
What If I Don’t Have Receipts for Last Year’s Business Expenses?
It’s tax time and you don’t have receipts for last year’s business expenses. Now what?
You can still claim deductions on your taxes without receipts for every transaction. Keep in mind that you don’t have to send your shoebox full of receipts to the IRS. You’ll only need them if you’re audited (which can happen up to 6 years after filing your taxes). However, it’s best to find documentation of every deduction you plan to take now rather than risking not having records if you’re audited a few years down the road.
If you don’t have original receipts, other acceptable records may include canceled checks, credit or debit card statements, written records you create, calendar notations, and photographs.
The first step to take is to go back through your bank statements and find the purchase of the item you’re trying to deduct. Print it out or save a file and make a note of when and where the item was bought, as well as how much you paid for it.
When it comes to travel expenses and business trips, if you don’t have receipts, you’ll need to do the same thing. Review your credit card statements, mileage logs, and calendar notations for records. For more information about what you can deduct when it comes to business travel, check out our detailed business trip deduction guide.
For other business-related purchases without records, it is wise to take a picture of the item purchased then write down where you bought it and how much it cost. If you know the name of the store, look up the item on the store’s website and write down the cost or take a screenshot of the listing.
Another way to account for lost receipts is to show a pattern of spending. If you started keeping records for your office’s monthly staff lunches halfway through the year, you could use your average expenses for those months to estimate the expenses for the months you didn’t track.
If you are trying to gauge how long to keep these records, here is a helpful guide:
Unfortunately, there is no perfect way to make up for original lost receipts. However, with today’s technology, you leave a record of spending everywhere you go. If you find yourself in the situation of not having last year’s receipts, vow to create a more organized tracking system from here on out so that you don’t run into this problem in the future. Here are a few ideas on tracking receipts for your small business this year.
If you are looking to eliminate the headache of your business taxes, reach out to our team. We help over 10,000 businesses across the US manage their bookkeeping and taxes. We would love to help!
FAQs: Handling Business Expenses Without Receipts
1. Can I still claim deductions without receipts?
Yes, you can claim deductions even without receipts. Alternative records like canceled checks, bank statements, written records, calendar notations, and photographs are acceptable.
2. How do I document purchases without original receipts?
Review bank statements or credit card records to identify purchases. Note down details like dates, amounts, and vendors. For travel expenses, utilize credit card statements, mileage logs, and calendar notations.
3. What if I can’t find records for business-related purchases?
If records are unavailable, take a photo of the item purchased and note the details. If known, retrieve information from the store’s website or use spending patterns to estimate costs.
4. How long should I keep records for tax purposes?
Refer to a helpful guide such as KeepItFor-01 for record retention guidelines. It’s crucial to maintain records for the recommended duration to ensure compliance.
5. How can I improve record-keeping for future tax seasons?
Invest in digital tracking systems and vow to maintain organized records to avoid similar issues in the future. Consider ideas for tracking receipts to streamline your small business’s financial management.
Running your own business is rewarding, but it can also be overwhelming. There are dozens of administrative tasks to keep tabs on besides your day-to-day work. I’ve been there, and I’ve felt that nagging feeling that I am letting something important slip through the cracks.
That’s why I wanted to put together these tips to help you stay on top of your finances while growing a successful business.
1. Plan for Current Business Needs
First, let’s talk about the importance of a business plan. How does an idea develop into a fully functioning business? It takes vision, work, and a good plan. To reach any destination, you need a good map. For entrepreneurs, we call this map a business plan.
Some essentials of a business plan include:
Researching competing products
Determining what sets your company or product apart
Conducting research into your market and client base
Estimating your costs and profit margin
Creating a marketing plan
Strategizing around how to pay yourself, your taxes, and other expenses
While there is a lot we could cover on the topic of business planning, for today we are going to focus on 3 important financial elements.
Tax Planning
Calculating tax rates can be tricky for small business owners. In addition to paying taxes on their income, many small business owners need to pay a 15% self-employment tax—which covers Social Security and Medicare taxes.
Because of this, I recommend that most business owners set aside 25% to 30% of their net income for taxes. Your net income is how much you make after you factor in all your expenses, so it’s your income minus any business expenses.
For example, if you earned $10,000 one month but spent $500 on new equipment, $250 on marketing, and $1,000 attending an educational conference, you would set aside 25% to 30% of $8,250 (your income minus all those expenses), not $10,000.
Expense Planning
How much will it cost to keep your business running? This should be something you evaluate and update regularly.
From marketing and production costs to rent and employee salaries, the expenses your business needs to keep functioning will be unique. Carefully think through any tools, equipment, and resources you need for your business. Once you’ve determined the estimated time and expense you will need to put in to your business, triple it!
No matter how carefully you plan, life happens and unexpected expenses will occur. Make sure you have enough wiggle room in your budget to handle the complications that will come your way.
Succession Planning
Setting up a succession plan includes planning for changes in your company and developing future leaders. Although succession planning doesn’t directly relate to finances, it can impact your financial planning and liability.
Think about and plan for how your business will continue to function if a key owner, partner, or employee leaves. Document processes and keep records so that if changes do occur, you still have the information you need to keep your business running smoothly.
2. Plan for Future Business Needs
Though there is a lot of uncertainty that comes with starting a business, begin with a long-term mindset by planning for the future success and growth of your company. Here are a few financial tips that will help you start on the right foot.
Set Up a Safety Net
Protect yourself and your investments as a business owner. Once your company begins generating revenue, set aside enough money to cover 2 to 12 months of expenses. Markets can change quickly. Having an emergency fund set aside will ensure you can keep your business running if an unexpected dip occurs or if you need a buffer to figure out new solutions.
In addition, diversify your investments as well as your markets. Having a diverse portfolio will protect you from sudden drops in any revenue source.
Plan for Retirement
Business owners have additional flexibility when it comes to their retirement contributions. Instead of being tied to a fixed percentage, you can adjust your retirement contributions to help lower your tax bill or bracket.
As you near the end of the year, talk to an accountant or a financial advisor to maximize your retirement contributions and tax savings. You can always reach out to our team for guidance about what is best for your specific situation. We would love to help.
3. Prioritize & Delegate
Small business owners are go-getters. But while we would love to do it all, we have to recognize that doing it all isn’t good for our sanity or our business.
Be smart about how you use your time. A survey by Sage showed that businesses around the world spend an average of 120 working days per year on administrative tasks, which impacts productivity and profitability. For small businesses, that number can climb even higher.
The takeaway is that the more time you spend figuring out books the less time you have to focus on growing your business. Find ways to lessen that burden so you can focus on what makes the biggest impact.
As a business owner, you will find there are a million and one things you can focus on in a day. Use your business plan to set a few realistic goals each month or each year. Then, use those goals to set your priorities.
Once you know your priorities, figure out what you can delegate or outsource. Find trusted partners or companies that can help you maximize your time.
4. Maximize Your Tax Benefits
There are several perks that come with owning your own business, including tax deductions. Take advantage of these benefits and understand how these deductions can impact your expenses in the long run.
You might be wondering, “How much will a tax deduction really save me on my taxes?” It’s important to weigh the costs of a business expense versus the actual tax savings to decide if that purchase is worth your money.
Luckily, we have a simple formula that can help you see the value of these deductions:
Business Expense x Tax Rate = Money You Save on Taxes
If you don’t know your tax rate, using 25% to 30% will give you a close estimate.
Once your plans and goals are in place, review them often. I’d suggest keeping a printout of your goals someplace you can see them as you work.
When you start to feel overwhelmed, look at your goals and focus on what you can do today that will get you closer to accomplishing those goals. That will help you tackle what matters most.
In addition to reviewing your plans, review your financial reports often. Get familiar with these reports and learn what they mean and how to read them. These will help you budget, make projections, secure loans or funding, and build a foundation for financial success!
If you still have questions regarding your business finances, taxes, or accounting, reach out to our team at Mazuma USA. We help small businesses save time, money, and stress managing their bookkeeping and taxes, and we would love to help you!
FAQs for Managing Business Finances:
Why is a business plan essential for financial stability?
A business plan outlines your vision, market research, costs, and strategies, crucial for financial stability and growth, offering a roadmap to success.
How should small business owners approach tax planning?
Set aside 25% to 30% of net income for taxes, considering self-employment tax. Deduct expenses from income and allocate a percentage for tax obligations.
What considerations are vital for expense planning in businesses?
Regularly evaluate and anticipate expenses, accounting for operational costs, marketing, salaries, and unexpected events, ensuring financial resilience.
Why is succession planning important for business owners?
Succession planning ensures continuity amidst personnel changes, safeguarding operations and financial stability by documenting processes and preparing for transitions.
How can business owners maximize tax benefits effectively?
Understand tax deductions and their impact on expenses. Utilize a simple formula to estimate tax savings and explore common deductions like business travel, equipment, and retirement contributions.
Financial planning is essential for anyone who wants to achieve financial independence. The goal of financial planning is to help you reach your financial goals, whether that be retiring by a certain age or having the money to open a new business. For small business owners, financial planning is especially important because you need to ensure you’re planning for your business as well as yourself.
Here are four tips to keep in mind:
1. Establish personal & business financial goals.
Because the purpose of financial planning is to help you reach your goals, you need to decide what you’re trying to obtain. It’s best to make these decisions with your family or business partners.
First, get with your family and decide what short-term and long-term goals you have for your finances. Do you want to buy or build a home? Do you want to go on a nice vacation every year? Are you planning to save for college for your children? When do you want to retire and what will retirement look like? How much money will you need for retirement? Once you set your priorities, you can begin to plan for those goals.
For your business, you’ll still need to set goals. How big do you want to grow? Do you want to get to the point where your business provides a passive income? While these goals are a big part of business financial planning, you also need to take into account how you’ll run your business. Are you setting aside money for taxes? What will happen when you (or a partner) leave the business? Do you have funds to pay your employees?
Determining what you want from your life or business can help you and a certified financial planner determine what steps you need to take to reach those goals. We’ll focus on business financial planning for the rest of this article, but talk with a financial planner to determine how you can meet all of your goals.
2. Set up a safety net.
Owning a business is a risky endeavor. Changes in the market can affect your business and leave you powerless. In order to brace for these changes, it’s smart to set up a safety net. With your financial planner, determine how much money you should set aside for your safety net.
One of the best ways to build a safety net is to diversify your income. This way, if one aspect of the market crashes you don’t lose everything. Typically small business owners have their money tied up in their own business, but you need more than that to build a safety net. Learn about different investments (stocks, real estate, precious metals, securities, etc.) so that you have multiple income streams. When you diversify your portfolio, you carry less risk.
3. Plan for your retirement.
Retirement planning is an essential aspect of financial planning, especially for business owners. Just because you love what you do doesn’t mean you want to do it until the day you die.
People who work for someone else often have retirement benefits through their job, but business owners don’t have that luxury. They have to plan for retirement on their own, which is why it needs to be on your radar. There are many different retirement options (401k, IRAs, etc.). Speak with a financial planner about which option is best for you. You’ll also want to look into the best way to fund your retirement plans. Since you don’t have your employer contributing, learn how you can contribute the maximum amount.
4. Plan for your current business needs.
As a small business owner, you have a lot of financial responsibilities. You aren’t just responsible for making money; you’re responsible for taxes, employee wages, business assets, and the list goes on. Here are a few things to keep in mind when you’re planning for your business:
Taxes
Taxes should always be at the forefront of your mind when it comes to business finances. You should always be setting aside at least 25% of your income for taxes. You also need to make sure you’re paying estimated quarterly taxes.
Different business entities (sole proprietor, S corp, LLC, etc.) all have different tax responsibilities. Make sure you know what your business entity requires. An accountant can help you determine how much you need to be setting aside for taxes according to your business type and can help you strategize how to maximize your tax return. If you have questions, reach out to our team at Vyde USA. We specialize in helping small businesses save time and money on their accounting, bookkeeping, and taxes.
Business Costs
When you are planning finances for your business, you need to factor in the cost of doing business. Every business has expenses, whether that be the expense of creating a product, employee wages, rent, equipment, etc.
It’s important that you find a way for your revenue to outweigh your expenses. Without that, you’ll never have a successful business.
Succession Planning
Setting up a succession plan, which includes strategizing around how to develop and grow future leaders in your company, should be a part of your financial planning. Although it doesn’t directly relate to finances, it can carry a lot of liability. You’ll want to make sure that your business has a succession plan for a number of scenarios: business partner leaving the business, death of a business partner, retirement, expansion, etc. No matter what the situation is, you’ll want to have a plan in place so that your business doesn’t suffer. Learn more about succession planning in this informative post.
There are a lot of other aspects of financial planning that small business owners should consider. It’s best to go over these with a professional to ensure you don’t overlook anything crucial.
If you're wondering, "How many years can I claim a loss on my business?" then you're probably reaching a point where you've been claiming too many losses on your taxes. The Internal Revenue Service (IRS) only allows your business to be in the negative for a certain number of years before it declassifies it as a business. We'll teach you the rules regarding business losses and help you determine if you can still claim your business on your taxes.
How many years can I claim a loss on my business?
The IRS will only allow you to claim losses on your business for three out of five tax years. If you don’t show that your business is starting to make a profit, then the IRS can prohibit you from claiming your business losses on your taxes.
After you claim a loss for three of the five years, the IRS will classify your business as a hobby. Hobbies are not tax deductible so you won’t be able to claim any of your expenses on your taxes. This declassification is called the Hobby Loss Rule.
How can I prove my business is more than a hobby?
If you want to continue claiming your business on your taxes, you need to show the IRS that it’s more than just a hobby.
First, you’ll have to show that you are running your business as a business, not as a hobby. You should meet these three criteria:
Have a business plan.
Show that you have plans, or at least intentions, to turn a profit.
Present business records that show you understand how to report business income accurately.
The IRS will also consider the following factors to determine if your business should qualify as a business or hobby:
Have you made a profit in the past?
Do you live off of the income made from the business?
Were your losses beyond your control?
How much time do you put into the business? Are you spending enough time to make it profitable?
Did you change your business methods in an effort in increase profits?
Do you have the knowledge to run a profitable business?
Your business should be able to positively answer at least a few of these questions. It takes more than just one to be considered a business.
What do I need to know about still claiming my business after it’s been classified as a hobby?
First, you need to understand that if you try to claim a loss on your hobby (even if you consider it a business), it could trigger an audit by the IRS. You need to determine if you want to still claim losses on your business after it’s been classified as a hobby. Typically, you can determine this by going through the questions we outlined earlier.
The best way to show the IRS that you’re a serious business owner is to keep records. Most people don’t keep records regarding their hobbies, so this simple tip can help prove that your intention is to run a profitable business.
Just because you feel like your business is more than a hobby doesn’t mean the IRS will agree. It’s best to talk with a professional accountant to assess the auditing risk associated with claiming your business on your taxes again.
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FAQs about Claiming Business Losses on Taxes:
How many years can I claim a loss on my business?
The IRS allows you to claim business losses for three out of five tax years. Afterward, it may classify your business as a hobby, making it ineligible for tax deductions.
How can I prove my business is more than a hobby?
Demonstrate you’re running a legitimate business by having a business plan, showing profit intentions, and maintaining accurate business records. Factors like past profits, time investment, and business knowledge also influence the IRS’s assessment.
What happens if my business is classified as a hobby?
Once labeled a hobby, claiming business losses triggers an IRS audit risk. To avoid complications, consider the questions outlined earlier to assess if your business qualifies, and keep meticulous records to demonstrate your seriousness.
Can I still claim losses after my business is classified as a hobby?
Attempting to claim losses on a hobby may lead to an IRS audit. Evaluate the risks and, if determined, consult a professional accountant for guidance on proving your business’s legitimacy.
How can Vyde assist with tax and accounting concerns?
Vyde supports small business owners with expert tax and accounting services, saving time, reducing stress, and optimizing financial management. Reach out for personalized assistance and stay on top of your finances.
Whether you know it or not, you could be leaving hundreds—even thousands—of dollars on the table by missing a few lesser-known small business tax deductions. Entrepreneurs often miss some small business deductions they could qualify for because they didn’t keep accurate records throughout the year, or they shy away from the complications of itemizing each expense. Avoid overpaying taxes this year by making sure you’ve reviewed all small business deductions to see if you qualify.
5 of the Most Missed Tax Deductions for Small Businesses
Business-Related Meals and Entertainment. Just keeping receipts on a business trip isn’t quite enough. Business owners who have an especially wide network and social schedule often spend thousands of dollars on eating out and entertainment for/with clients throughout the year. Many don’t keep accurate records and aren’t sure if they can really classify the meetings as “business-related.” However, keep in mind, there is no hard and fast rule about how much of the meeting must be taken up by business talk. You can safely deduct 50% of your meals as long as you can show a new client lead or referral came from the meeting. If you haven’t been saving your receipts this year and think you may have missed deductions in this area, a bank statement will suffice.
Calculating Vehicle Expenses. Sure, $0.57 per mile driven can really add up when you take a road trip across the country to further your business. Most business owners find the Standard Mileage Rate to be more than fair, but it’s worth calculating vehicle expenses the hard way if you are really looking to save on your tax bill. Believe it or not, the “hard way” really isn’t all that hard. First, divide business-related by your total miles driven for the year. This will give you a percentage. Take that percentage and apply it to gasoline costs, car washes, new tires, oil changes—even a satellite radio fee or new seat covers. You can calculate “anything that is for the betterment of the vehicle.” Keep in mind that miles driven to and from the office each day do not count as “business.”
Home Office—The Hard Way. The IRS allows a simple home office deduction of $5 per square foot. Again, more than fair for some business owners, but others take the long route and find that it works to their advantage. Calculating your home office using the traditional method involves measuring the office square footage, and dividing it by the total square footage of the home. You can then apply that percentage to home-related expenses such as electricity, heating, mortgage payments, and home depreciation. Calculate your home office deduction both ways and find which works better for you.
Startup Costs. An often forgotten deduction comes in the form of expenses incurred before your business actually opened its doors. The great thing about startup costs is that there is really no limitation on how far back these expenses can be counted. If you took a continuing education class, bought a computer that is now used for work, took a future client out to dinner, you can count those as deductions. The IRS allows a deduction of up to $5,000 for the first year, and the rest amortized over the next 15 years.
Employee Expenses. If you reimburse clients for any business-related expenses, don’t forget to keep track. Other employee expenses include gas, meals, hotel accommodations, tips, baggage fees, etc. You can also deduct the cost of gifts given to clients, as well as wrapping and shipping costs associated with those gifts.
This is obviously not an exhaustive list of commonly missed tax deductions—pet moving expenses, the cost of quitting smoking, clarinet lessons (yes, all real!)—but these are certainly the most common for entrepreneurs and small business owners. If you need help knowing what is and isn’t tax-deductible and making sure you are within IRS regulations, our accountants can help. Reach out to us today!
Frequently Asked Questions:
1. How can I ensure I don’t miss out on small business tax deductions?
Maintain accurate records throughout the year. Review all possible deductions to maximize savings and avoid overpaying taxes.
2. What are the deductions related to business meals and entertainment?
Deduct 50% of business-related meal expenses if they contributed to new client leads or referrals. Bank statements can suffice if receipts are unavailable.
3. How do I calculate vehicle expenses for tax deductions?
Use the Standard Mileage Rate or calculate expenses based on the business-related percentage of total miles driven, including various vehicle costs.
4. What’s the process for claiming a home office deduction?
You can opt for the simplified $5 per square foot deduction or calculate expenses using the traditional method based on office square footage.
5. What are deductible startup costs, and how far back can they be claimed?
Startup costs incurred before business commencement can be deducted, with no specific time limit, up to $5,000 in the first year and the rest over 15 years.
We talk with clients everyday about their business and we love it. As accountants, we spend a lot of time with the books and we love the numbers and details, but we get that not everyone does.
Part of growing your business is knowing when to pull the lever to hire a professional rather than continue to DIY things yourself.
So when is the right time to hire an accountant? We’re glad you asked.
When You’re Deciding on Your Business Structure
Hiring an accountant when you’re first starting out might seem a little premature. But you’ll want the financial advice and wisdom that comes from a seasoned professional as you figure out the type of business structure, or entity, that you need to set up for you business.
An accountant will be able to provide you with the ins and outs of each business entity type and help you formulate which one will be best for you and your company in the long run. Additionally, they’ll be able to help you manage your money as you set out to establish yourself. If numbers aren’t your thing, we highly recommend at least sitting down with an accountant for an hour or two to hash out the starting details and a gameplan for your first year or so in business. Then at that point, you can reassess to see if outsourcing your finances to an accountant and bookkeeper is a better fit.
When Things Get Complex & You’re Ready to Delegate
So you’ve DIY’ed it so far and it’s been just fine. As you start to grow your biz and things become more complex you might find that you lack the time to keep a handle on your finances along with all the other aspects of your business.
Hiring an accountant as you enter this more complex stage is a great idea. They can help you move from a side hustle or brand new biz to a more complex one that’s investing in growth and the future. Don’t feel like it’s a statement about your ability to juggle it all, rather celebrate your success and hire that accountant to help you fast track to the next level.
When You Have To Deal With The Government
Everyone, and we mean everyone, feels that pit in their stomach when they hear IRS. Hiring an accountant when you have to work with the government, and even before, helps gives you peace of mind – and accountants are good for more than just managing an audit or keeping you safe from one. Accountants should also be able to help you with:
keeping you up to date with the most recent tax law
keep your company’s status updated in the gov’s company register
handle your payroll and ensure that dealings with employees are documented and done correctly
complete and file all legal paperwork and compliance documents for your business
When You’re Applying for a Business Loan or Looking for Investors
So your business is growing and you’re looking to expand even further. But it takes money to make money and the type of capital you’re looking for is going to have to come from a bank loan or an investor.
Banks and investors like to see that they’re going to get a good return on the money they loan out, and an accountant will be able to showcase that your company is a good bet. Accountants can help you prepare the paperwork for the loan, choose the right type of loan, and even pull together the records that you’ll need to show how impressive your business is so that you’re a shoe-in for getting that loan.
Have additional questions about hiring an accountant? We’d love to chat.
FAQs about Hiring an Accountant for Your Business:
When is the right time to hire an accountant for my business?
It’s advisable to consider hiring an accountant when you’re deciding on your business structure or when your business operations become too complex for you to manage effectively on your own.
What role does an accountant play in deciding on a business structure?
An accountant offers valuable financial advice regarding different business entity types, helping you understand their implications and choose the structure that aligns best with your business goals and financial situation.
When should I involve an accountant in dealings with the government, such as IRS matters?
Hiring an accountant when you need to engage with government agencies, including tax authorities like the IRS, provides peace of mind and ensures compliance with tax laws and regulations. Accountants also assist with tax law updates, payroll management, and legal paperwork.
How can an accountant assist in securing business loans or attracting investors?
Accountants play a crucial role in preparing loan applications and financial documentation for investors. They help showcase your business’s financial health, choose the right financing options, and ensure compliance with regulatory requirements, increasing your chances of securing funding.
What additional services can I expect from an accountant beyond financial management?
Besides financial management, accountants offer expertise in tax planning, payroll administration, compliance management, and financial forecasting. They serve as valuable advisors, helping you navigate complex financial decisions and optimize your business’s financial performance.
Even though we’re accountants, we get that financial reports aren’t at the top of every small business owner’s to do list. Most small businesses run on slim budgets and personnel staff of one or just a few. But whether you keep your own books or employ the services of a bookkeeper or accountant, understanding the numbers can help your small business just as much as it could help a large corporation. So lets cover some basics so that you’re ready to make sense of it all and succeed with your business.
Know the Key Terminology
It goes without saying that understanding the terminology will help a ton in understanding your financial reports. We cover quite a bit of it here on the blog but you can also easily find it just by searching the term on the internet. Our best advice, read through this post and the one we link to down below. Search definitions for any words you don’t know, and jot down definitions in a notebook or sticky and put it with your financial paperwork. If you’ve got a bookkeeper or an accountant on hand – ask them. You’re more than likely paying for their services, so schedule a time that you can pick their brain, or ask for an entry-level crash course to the financial reports that they’re creating for you. No matter how you go about it, you can always come back here and look for those key accounting terms explained – we have a word of the week posted here on the site and you can learn about the first one, income statement, right here.
Be Consistent in Reviewing Your Financials
There is absolutely no reason to make sense of your financial reports if you’re not going to read them – on a regular basis. So right now, before you even dive into your first report, pull out your phone or your work calendar and set a monthly meeting for you and your books. Consistently reviewing the financial reports will help you create long term strategies to grow your business or expand your product line or services. We promise the time you commit to reviewing your financial reports monthly will be well worth it.
Why are financial reports important for small businesses?
Financial reports provide insights into the financial health and performance of your business, guiding strategic decision-making and growth.
How can I understand the key terminology used in financial reports?
Search online resources for definitions, ask your bookkeeper or accountant for guidance, and explore educational posts and resources provided by accounting professionals.
Why is consistency crucial when reviewing financial reports?
Consistent review of financial reports enables you to track progress, identify trends, and make informed decisions to drive business growth and expansion effectively.
What benefits can regular review of financial reports offer to small businesses?
Regular review helps in identifying areas for improvement, adjusting strategies, and setting long-term goals to enhance business performance and profitability.
Where can I learn more about interpreting financial reports for my small business?
Explore comprehensive resources and educational materials provided by accounting professionals to gain a deeper understanding of financial reports and their implications.
We work with small business owners and entrepreneurs. Some are seasoned, others are just growing their side hustle. Their skills are varied and they have a wide variety of talents. We often get asked to explain the ins and outs of financial reports and have found that providing our favorite clients with a working knowledge of accounting terms is helpful. With that end in mind, we’re sharing that expert knowledge with you. So if you’re looking to get a better grasp on your small business books, want to understand your financial reports so you can make better business decisions, or even are just starting out and want to do it right… you can check out our word of the week and start expanding your working financial knowledge.
What Are Cost of Goods Sold (COGS)?
The Cost of Goods Sold (COGS) is is simply the amount it costs to produce your product or provide your offered services. You may have even heard your bookkeeper or accountant refer to COGS as the cost of sales or services. COGS include both the material and labor expenses that go into production of each good or service sold, so be sure not to leave either piece out.
COGS don’t include indirect expenses like utilities for your building, your marketing expenses, or shipping fees – it’s merely the cost of what it takes to make your product – we’re talking raw material and direct labor on this one. Here’s a simple formula that will give you COGS:
COGS = Beginning inventory + Purchases During the Period – Ending Inventory
Beginning inventory is whatever is left over from the previous accounting period (usually monthly).
Purchases during the period is on the direct labor or raw materials that were paid for during the accounting period.
Ending Inventory is whatever product you haven’t sold by the end of the accounting period.
We mention monthly accounting above, but your particular business could run accounting periods either monthly, quarterly or by calendar years. Make sure you know and take that into account as you’re figuring you’re COGS.
How Does Knowing Your Cost of Goods Sold Help?
To be able to know if you business is turning a profit, you’ll need to know your COGS. Additionally, knowing your COGS can help you better determine the pricing structure for your products or offered services. You’ll also be able to use the number you have for COGS to help you figure out your business’s gross profit or the amount your business earns from your products and services before taking out taxes and other expenses.
If you’re not already tracking the numbers you need to computer your cost of goods sold, it’s time to start. Doing so will help you figure out your COGS as well as help you make your business incredibly profitable.
Frequently Asked Questions (FAQs)
1. What is included in the Cost of Goods Sold (COGS)?
COGS includes the direct costs associated with producing your product or providing your service. This encompasses expenses like raw materials and direct labor. However, it does not cover indirect expenses such as utilities, marketing, or shipping fees.
2. How do I calculate COGS?
To calculate COGS, use the formula: COGS = Beginning Inventory + Purchases During the Period – Ending Inventory
Beginning Inventory: The amount of inventory left over from the previous period.
Purchases During the Period: Costs of raw materials and direct labor incurred during the current period.
Ending Inventory: The value of inventory that remains unsold at the end of the period.
3. Why is knowing my COGS important for my business?
Knowing your COGS is crucial because it helps you determine your business’s profitability. By calculating COGS, you can better set pricing for your products or services, assess your gross profit, and make informed financial decisions to enhance profitability.
4. How often should I calculate my COGS?
The frequency of calculating COGS depends on your accounting period, which could be monthly, quarterly, or annually. Regularly updating your COGS helps you maintain accurate financial records and make timely business decisions.
5. What should I do if I’m not currently tracking my COGS?
If you’re not tracking your COGS, it’s important to start as soon as possible. Begin by documenting your beginning inventory, tracking purchases, and updating your ending inventory. This will help you compute COGS accurately and manage your business finances more effectively.
