I’m not looking for advanced tax advice, I am just wondering about something. If a person starts a business with the intent of using that business for tax writeoff purposes is that illegal or legal?
Like lets say someone starts a daycare center 2 days a week and as a result tries to write off their mortgage, some utilities, some household expenses, their car and some gasoline payments (since the car is used to pick people up and drop them off) as business expenses. Is that illegal or legal?
Operating a business for the sole purpose of tax writeoffs – creating expenses in excess of receipts – seems to be legal. TWA and K-mart followed that business model for many years.
I believe that you have to show a profit in at least two years out of five in order to qualify for tax deductions as a self-employed individual. If you continually show a loss the IRS can come after you for back taxes on the deductions.
I’m not a tax attorney, but my understanding is that it’s not legal. The business must purportedly exist with the intent of making a profit – someday. That doesn’t mean it must make a profit (a number of businesses don’t even when trying to), and obviously no one can read your mind, but I believe that if you declared you had no intent of ever making profit and were only looking for a tax write-off that it would be a violation.
I believe this falls under what is referred to as the hobby loss rules.
*If you are in business with the objective of making a profit, you can generally claim all your business deductions. If your deductions exceed your income for the year, you can claim a loss for the year, up to the amount of your income from other activities. Remaining losses can be carried over into other years.
However, your ability to deduct these losses will be limited if the IRS considers your business to be a hobby.
Losses incurred by individuals, partnerships and S corporations in connection with a hobby are generally deductible only to the extent of the income produced by the hobby. In other words, you can’t use a hobby to generate a tax loss that can be used to shelter your other income. *
This link should give you more than all the information you need to dissuade anyone from considering this. Then again, it might not, but I think you’ll get the idea 
And, as Exapno Mapcase says, though I haven’t found a site for it, if a home based business continues to not show a profit, IRS can and will make a case that the venture is not a business entered into for profit, but rather a hobby.
And because I’m slow, welcome to my first triple simulpost 
The rules are like a labyrinth, with lots of pitfalls. Here are a few high points.
If you want to write off your car, it has to be used almost entirely for business.
If a small business goes more than (I think) three years without turning a profit, the IRS may call it a “hobby business,” and all your advantages are gone.
If you run a business from your home, hoo boy! That’s complicated. You need a lockable door between home and business. You need an outside door to the business; no bringing customers through the parlor. Separating utility expenses gets complicated. In short, you can’t claim the whole house is a place of business if you still live there.
I have only scratched the surface, and am not a tax expert. Nearly all of the above is from the radio show Sound Money from Minnesota Public Radio.
http://soundmoney.publicradio.org/
Profit or no, if you try to deduct ordinary household expenses for business, you’d better have scrupulous records to back up your claims. IIRC, home-based business expenses are one of the major topics of IRS audits.
You can deduct any expenses required to run a business. Thus, art supplies, milk and cookies for the children (though only for them), postage, etc. are all legitimate business deductions.
Writing off the car is iffy, but you can get a deduction for mileage. If you can document you drove 200 miles during the year while dropping off the kids, then that’s legit.
In-home deductions are difficult. At one time, you used to be able to deduct a portion of your costs, determined by the square footage: if your office took up 25% of the total square footage, 25% of your mortgage, utilities, etc. could be deduction. But those days are long past. Now you need to document that the area being deducted is used solely for business. If you set aside a room for the day care center, then that room could potentially be a deduction. However, the IRS is quite narrow in how it interprets this, and it’s very likely your deductions will be disallowed. You’ll need a tax expert to advise exactly how things need to be set up.
If any equipment is bought for business purposes, you can also get a deduction for depreciation. Again, a tax expert will explain how to use that.
And, of course, you need to show that you are intending on making a profit. The two-out-of-five-years rule is a rule of thumb. If you lose five years in a row, your deductions are not necessarily disallowed. If you can prove you were intending to make a profit to the IRS’s satisfaction, then they will allow them. (If you make money 3 out of 5 years, that’s usually enough to prove to the IRS it’s not a hobby.)
The rules prevent a small business from becoming solely a tax writeoff. Big corporations can get writeoffs due to special incentives and depreciation that isn’t available to a small business.