Let’s say I acquire a substantial sum of money. It’s being managed by professionals and I don’t really need to get involved in managing it - I just collect the income.
Now I could buy a mansion or a yacht and spend all my days partying. But I’ve always had a dream of running a nightclub. Or maybe a restaurant. Or a movie theater or a comic book store or a gas station. Whatever. I have some idealized vision of some small business that I want to run and now I have the money to make my dream real.
So I buy a building and all the equipment I need and hire a bunch or employees and open up for business. And everything is as good as I dreamed it would be and I’m happy. Then a few months later, one of my money managers shows up and tells me that my business is a terrible idea. I’m not earning a fraction back of what I’m putting into the business and there’s no realistic probability that that’s going to ever change. So I do my Charlie Kane impression and tell him it doesn’t matter if I’m losing ten thousand dollars a month in my business because at that rate it’ll take me a hundred years to spend everything I’ve got. Running this business is how I choose to spend my money so I’m going to do it.
But while that may have worked a hundred years ago, I suspect that things are more complicated now. I’ve heard that there are tax laws that basically give you a limited grace period in which your business can show a loss. After that they have to earn a profit or they’ll no longer legally be classified as a business. What are the details of this?
When I learned german tax laws, we covered this topic shortly, but small-scaler. The example was that your wife /husband has a little hobby on the side - ikebana, pottery, painting, whatever - and you declare it a self-run business. Then you put all the materials she’s buying for her hobby, and the courses she goes to, under “expenses” for the business and subtract it from the gross. However, the teacher said, the Tax office gives you only a certain period - I think 4 years, but maybe 10 for the artistic stuff - to break even into the black with the stuff the hobbyist is supposed to be selling. Otherwise, they’ll simply declare it a hobby, and you can no longer subtract the costs.
Showing that she went to dozens of art shows to try sell her paintings and had exhibitons in your local bank and otherwise made serious effort would help your case, not doing serious efforts would hinder it.
Now, in your example, you’re employing people. So I wonder how the IRS could call it no longer a business?
However, in your scenario, you’re proposing a fairly extensive business that you’d likely want to set up as a corporation; I presume the tax laws are different in that case.
I don’t know tax law. But I’m thinking there are things the IRS could do that would affect my hypothetical business. Suppose they declared that it was no longer a real business for tax purposes. I could no longer claim things like the rental of my store property or purchase of office supplies as business-related expenses. I’d have to pay sales tax on the products I bought for resale. There’s probably a bunch of other things I haven’t thought of, which is the point of this thread. What are the consequences of having a business declared to not be a real business?
So if I incorporate my hypothetical business and am willing to write a check every month for the expenses that it didn’t make back through income, I can theoretically keep running my business forever (or until my checking account runs out)?
There is no law that says a corporation has to make a profit, if you keep running it as a loss that should be OK as long as you can cover the losses out of your own pocket.
This is a good point. If it’s your business, you can run it at a loss forever. Whether you can deduct the losses from income, and from what income you can deduct it, are more complicated issues.
Yes, the tax issues are something I can’t comment on. But there are businesses that never turn a profit , the fold when they run out of cash. For example tech startups sometimes only last a few years if they can’t get a product out the door before their cash runs out.
That was the premise of “The Newhart Show.” Dick tells his wife JoAnn that even though they now own the inn, they need never make a profit because he makes more than enough money from all the “how-to” books he writes.
I would say it is a shame you are in New York, as i would love to run a gas station, but do not have the start up capital.
If you do want to start a business, and have others do the running around, have you considered looking at the local universities or business colleges and finding out if they have any programmes which might help you find a interested party?
I have heard that at the university of Houston, they have a set of classes where you can train under a retired/owner of a business and they assist you to set up and learn the practical ropes. It is possible you might be able to partner with someone there. You supply the capital, they supply the experience, and a grad student provides the management.
I do not understand this whole thread. I have to file a separate Schedule C for each business that I have. If one of my businesses has a loss, then the number at the bottom of that form is zero, and it is NOT a negative number which can be used to offset my profitable businesses.
I can keep running that business forever, and never pay taxes on it, because it never has a profit. Why would the government insist that I shut down a business just because it doesn’t show a profit?
I’m not a tax lawyer, so I don’t know how you have your businesses set up, but in general one can claim a loss for a business, and carry that number over (as a negative) to one’s Form 1040. Take a look at the bottom of Schedule C if you don’t believe me.
You misunderstand. The IRS doesn’t shut down your business, it just limits your ability to claim a loss (in other words, the IRS treats yous business as a “hobby” for tax purposes). Otherwise, people would claim their stamp collections as businesses and take all their stamp purchases off their income every year.
I looked, and you are correct. I think that it was the requirement of filing separate Sched Cs for each business that made me think that losses on one could not offset another. Thanks for setting me straight. (Fortunately, being a self-employed contractor, I never had a loss on any of my Sched Cs, so this error did not really affect me.)
Hmmm. I think that losing the ability to deduct losses (because they are treated as hobby losses under Section 183) is the only real impact of being treated as a hobby. Others are correct that this treatment would apply only if the business is held in a pass-through manner (ie, as a sole proprietorship, S corp, or partnership). This won’t impact sales or property or franchise or any other state or local tax (except that most state income taxes use federal taxable income as the starting point, so you’d lose the deductions for state income tax purposes too). Also, you’d still have to withhold tax and pay FICA etc on your employees’ wages.
One possible collateral consequence is that maybe you’d lose the ability to have the business set up certain types of retirement plans or health plans because one of the qualifications for those plans may be an actual business. This is just pure conjecture, but it seems like there could be abuse if I set up a “business” and lose a dollar a year but can qualify to save for retirement or health expenses in a tax-advantaged manner. This consequence could maybe apply even if the business were held through a C corp.
Wait, so you’re saying I can decide that I now own a “knitting business” and/or “yarn store” and for a certain period of time happily deduct all expenses occurred in the running of said “businesses”? Without paying any expenses necessary to incorporate (which would be stupid and prohibitive in my case)?
I knit a guy a pair of socks last week. He paid for the yarn and I charged him what amounted to about a dollar an hour for “labor.” Does that count as “business” for tax purposes?
No. You have to have a profit motive in the first place. If you don’t have a profit motive, you can’t deduct any expenses. If you do have a profit motive, then 183 may apply to disallow those deductions.
Don’t forget to apply for, file, etc, your business licences, local taxes if any, sales tax, etc. In addition your income taxes get more complicated. It doesent take much to get to the point where keeping your baby business needs money to keep itself solvent just in licences and basic materials.