How long does my business have to make a profit?

I have a business that has sales under $30,000. Expenses have shown a total loss. I have been told by others that you can't operate a business with a loss for more than 3 years. Is this true? How do you grow a business to profit if you are only allowed 3 years?

Small Business, Small Business Financing
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October 2016
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I am assuming your question is in regard to taking losses on your tax returns and IRS regulations. There are general guidelines around how long you can take losses, but if you can prove you had a profit motive you may be able to take the losses for more than the general guidelines dictate. I have helped clients do this in the past when they have received a letter from the IRS disallowing the loss by explaining the business and profit motive. 

The general overview is this which I have taken straight from the income tax handbook. Let's say your business claims a net loss for too many years, or fails to meet other requirements, the IRS may classify it as a hobby, which would prevent you from claiming a loss related to the business. If the IRS classifies your business as a hobby, you'll have to prove that you had a valid profit motive if you want to claim those deductions.

The IRS allows you to take a tax deduction for legitimate losses incurred in the operation of your business. However, if your business claims a net loss for too many years, or fails to meet other requirements, the IRS may classify it as a hobby, which would prevent you from claiming a loss related to the business. If the IRS classifies your business as a hobby, you'll have to prove that you had a valid profit motive if you want to claim those deductions.

The IRS expects that if you start a business, you intend to make money at it. If you don't, your business is likely to be a hobby. To determine if your business is a hobby, the IRS looks at numerous factors, including the following: 

Do you put in the necessary time and effort to turn a profit?, Have you made a profit in this activity in the past, or can you expect to make one in the future? Do you have the necessary knowledge to succeed in this field? Do you depend on income from this activity? Are your losses beyond your control?

General Rule:

If you have not turned a profit in at least three of the prior five years, the IRS will categorize your business as a hobby. This may be extended to a profit in two of the prior seven years in the specific case of horse training, breeding or racing. This is, presumably, because these endeavors involve a great amount of risk.

Consequences of being called a hobby:

Generally, the IRS classifies your business as a hobby, it won't allow you to take any losses. However, in certain limited situations you can use your hobby expenses to reduce your taxes.

If you have a hobby loss expense that you could otherwise claim as a personal expense, such as the home mortgage deduction, you can claim those expenses in full. Other expenses, such as advertising, wages, insurance premiums, depreciation or amortization, may also be usable. However, you must have earned more total income in your hobby than the amount of all of these deductions, including your personal deductions. In that scenario, it's likely the IRS would categorize your hobby as a business anyway.

Preventing your business from being classified as a hobby:

Running a hobby as a business could very possibly trigger an IRS audit. If your business is legitimate, keeping accurate and extensive records could help prevent the classification of your business as a hobby.

In addition to demonstrating your professional approach to your business, records and receipts can help document your profit motive. A written business plan is often a prerequisite for indicating an intent for profit, and it can also show ways in which you are modifying your business to cope with losses

Make sure you keep your personal and business expenses separate also (don't co-mingle):

Hopefully these guidelines will help you however you can always try to prove your profit motive if you go over what the general rules state and win if the business is legitimate. 

October 2016