Find someone who has paid for an item that might serve a business purpose and you’ll have a person who wants a tax deduction. One of the rewarding satisfactions from mastering tax subjects in CPA study materials is that you can save these people from themselves.
An accountant finds plenty of opportunities to show people the limitations to tax deductions. This explains frequent issues CPAs field about deducting personal expenses. Occasionally, expenses are associated with earning money. However, earning sideline income is not necessarily a business venture. Taxpayers can make an activity seem like a business when it really isn’t. Accountants are prepared to recognize these situations because they are similar to CPA exam questions that present an untidy mixture of facts. As a result, CPA education renders substantial ability to distinguish reality from surface appearance.
A vital area of CPA exam courses that applies to common events in the life of a tax accountant is hobby income. Any activity is a hobby if the taxpayer receives income but doesn’t operate with a clear plan for profitability. Alert CPAs often find individuals claiming that a hobby is a business.
A recent case that landed in Tax Court proves this point and more. The taxpayer owned a proprietorship consisting of an aerial photography service. In 2007, the business owner decided to expand into selling light aircraft. The taxpayer’s first mistake was including the new activity in the tax reporting with his established aerial photography operation. He must not have relied upon a CPA for tax return preparation. An easy rule to recall from CPA study material is that proprietorships involved in different activities are reported on separate schedules.
The taxpayer attracted the attention of the IRS because his single Schedule C reported a loss of $90,000 from revenue of only $10,000. The IRS claimed the entire operation was a hobby. The Tax Court did not agree completely and instead relied upon another part of tax law involving start-up costs. According to the Court, the aircraft sales company was a separate business that did not begin operation until after 2007. All the money spent on this activity in 2007 was prior to the taxpayer establishing a dealership and advertising the business in 2008.
This triggers another subject from CPA review classes. Start-up costs are the amounts spent before operations begin. After an enterprise is ultimately launched, the first-year tax deduction of start-up costs from the past is limited to $5,000. Any excess is amortized over 15 years. This case gives CPAs a new example illustrating the importance of separating start-up costs before a business becomes active from expenses after operations begin. Even an existing proprietor who launches a new venture needs CPA advice about segregation of start-up expenses.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.