With more and more Americans turning both hobbies and new pursuits into side businesses, understanding the IRS rules for hobby vs. business ventures is more important than ever. Can your side gig pass muster if the IRS asks for more information? Here are five ways that an accountant can help you ensure that it does.
1. Determine If You Made a Profit
The easiest way to convince the IRS that your side gig is really a business is to turn a profit. Ideally, you'll see positive results in your bank balance. However, remember that it is possible to turn a profit in your bookkeeping but not based on IRS tax reporting rules — and vice versa. So work with an accountant to learn if you may be doing better than you thought.
2. Maintain Proper Business Records
For this enterprise to be treated like a business by the IRS, you should first treat it like a business. This means tracking income and expenses, balancing bank accounts, invoicing customers, and even producing fledgling financial statements. Your accountant can help you set up a system appropriate to the size of your business and your goals, and they can also help you maintain it over time.
3. Separate Business Activities
The separation of personal and business transactions is a cornerstone of businesses. Most entrepreneurs should open a separate business bank account and run transactions through it. But there should be no personal expenses mingled in. If you're not sure whether or not you have sufficient separation of your personal and business life, a qualified financial pro will help you improve.
4. Make Changes to Boost Profit
If you haven't made a profit in several years, you're at risk of creating an IRS red flag. However, don't give up hope that you can still call it a legitimate business. If you can show the IRS that you are attempting to right your profit-making ship, you gain more time. Analyze your finances, transactions, cost of goods sold, and losses with an accountant to find ways to make improvements and then document these efforts.
5. Project Future Profit Margins
Do you have an honest reason to believe that your business will start making a profit soon? This can also buy time. Perhaps, for instance, you started out with a large loss but that loss has gradually grown smaller over several years. You're on the right track, but you may need more years to get out of the red. A good accountant can draw the line so that you have a strong case with the IRS.
Where to Start
Could you use assistance making sure the IRS doesn't reclassify your entrepreneurial project as a hobby and raise your tax bill? If so, start by meeting with a qualified accounting service in your state today.
Reach out to an accounting service for more information.