Many new small businesses take time to get off the ground and become profitable. When a new sole proprietor or single member LLC owner reports the business activity on the Schedule C, they often ask me how many years can they deduct a loss on this activity.
A key component of owning a business is to make a profit. Sometimes initial expenses are large and it take a couple of years to show profit. Taxpayers must show all business income and expenses on their tax return but sometimes the IRS might limit losses because the activity looks more like a hobby than a business. A good example are multi-level sales companies such as selling candles, jewelry, skin care or other products. These activities can result in losses year after year and the IRS may consider the activity to be a hobby.
Generally, taxpayers can only deduct hobby expenses up to the amount of hobby income. If hobby expenses are more than revenue, taxpayers have a loss from the activity. You can deduct ordinary and necessary expenses required to generate revenue; however, a hobby loss is not allowed.
The way you conduct your business can make a good case for your business loss deduction. Here are the recommendations from the IRS:
If you operate a business and you incur losses, you can take these losses on your tax return. Be aware that the IRS may consider your activity a hobby if you have losses for more than three years out of five and you are not taking the steps above to show that you intend to make your business profitable.
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