If you’re wondering, “How many years can I take 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 take 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.
If you need additional tax or accounting help, reach out to our team at Mazuma USA. We work with small business owners to save them time, stress, and money on their taxes and stay on top of their finances.
Ben Sutton is the founder of Mazuma USA, an accounting firm providing tax, bookkeeping and payroll services to small businesses. Since founding Mazuma, Ben has established himself as an expert in the small business world. He’s still driven by that same desire to provide accounting help to all small businesses – from photographers, bloggers and creatives to lawyers, doctors, and dentists, everyone needs affordable accounting help. Ben is a Certified Public Accountant, and a member of the American Institute of Certified Public Accountants. But Ben considers his greatest achievement and credential to be his happy wife and four children.