As most planners are aware, clients who own their own business are entitled to deduct any losses incurred as a result of running the business (IRC Sec. 162(a) and IRC Sec. 212(a)(1)-(2)). However, if clients misclassify their operations as a business, when the IRS would classify them as a hobby, they could be on the hook for back taxes, as the IRS will disallow their loss deductions (IRC Sec. 183(a)). Within the IRS regulations, there are nine factors which, when applied to a client’s situation, will point in the direction of either a business or a hobby. Planners can create value for their clients by implementing strategies around these nine factors to help prove a clear, intentional profit motive if a client’s business is ever under review. This paper seeks to explain the purpose and use of each factor, as well as highlight planning opportunities that each factor presents.
Kevin Tacchino, MSTFP, earned his master’s degree in taxation and financial planning from Widener University in 2018. He currently works for the treasury department of a large global retailer. Previously, he worked with small-business owners to help them navigate a myriad of start-up issues and discussions.
Stephanie Wendling, CPA, MSTFP, is a lecturer at Widener University where she teaches tax and financial planning courses at the graduate and undergraduate levels. Tax is the primary focus of her research. Stephanie received both her bachelor’s degree in business administration with a concentration in accounting and her master’s degree in taxation and financial planning from Widener University in Chester, Pennsylvania.