Factor 2 is somewhat similar to the first factor relating to the time and effort put into the activity.  But it starts to get a little deeper.  The question is, “do you depend on income from the activity?”  I would like to add a few more words “for your survival?”  Some activities make money; some make lots of money, and lots of times you have to spend a lot of money to make this money.  But, are you relying on this activity to be able to pay your bills this month?  If so, it is much more likely that your activity is a business rather than a hobby.  If you are doing the work and just piddling around with the little bit of money that you are earning it may not be considered a business.

Keep in mind that none of these factors are determinable in themselves in the determination of “hobby or business” but they are each considered in the equation by the IRS.

Anyway, the first of the factors is: does the time and effort put into the activity evidence an intention to make a profit.

So this one sounds easy enough.  The underlying assumption is that if you are working and trying to make a profit you are going to be putting a certain level of effort into the activity.  Now just putting effort into something does not mean you are working in a business.  You also have to be working towards making a profit.  For example, I enjoy video editing.  I do a lot of work for myself and for my church.  I spend a lot of time on this for several reasons: first, because I don’t spend a lot of consistent time doing the work, it takes me longer to get it done; second, the work, by its nature, takes a long time.  I, therefore, spend a lot of time doing the work.  On the other hand, I do some projects as a business.  I do several things activity to show that I am working toward making a profit.  First of all, I spend some time advertising, we spend time working with clients, I manage costs, keep up with records and do professional work.  I may not spend 40 hours per week doing this work, but that is not required.  Making sure the time and effort that you are putting toward the work is with the intention to make a profit and not just for fun is the key to this factor. 

Any questions?  Make a comment on this post and we can continue the conversation.

Lawyers like to call this piercing the corporate veil.  This is because one of the positives in performing your work from within a corporation is that your personal assets, etc. are protected from corporate creditors.  Therefore, if you own a contracting company that is incorporated and you tear up someone’s property, they can only sue the corporation and get damages from the corporation – not from your personal checkbook.

In some instances, creditors (including the IRS) can “pierce the corporate veil” to reach in to the assets of the owners of the business personally.

The IRS can reach into the personal assets of a business’ owners if the corporation fails to pay the payroll taxes that it holds in trust from employees’ wages.  This does not include corporate income taxes, just the portion of the taxes the corporation is supposed to withhold from the employee and hold in trust for the government.  The IRS calls this the trust fund penalty, and it allows them to collect from anyone who has authority to write checks, or who is in charge of payroll.

I have written a couple of trust fund recover penalty articles:

What is the Trust Fund Recovery Penalty

Who is Responsible for the Trust Fund Recovery Penalty

Can I Reduce My Trust Fund Recovery Penalty with an Offer in Compromise?

Keeping good records does not mean throwing all of your receipts into a box for your accountant to decipher at the end of the year.  And speaking of accountants, if you’re in business then you need to have an accountant who is not going to just prepare forms and returns for you, but also will help you with your tax planning to make sure you get the most out of your business.

Here are the top 5 reasons to keep good financial records for your business:

1.  Keeping up with the Progress of your Business

Part of running a successful business is being able to make decisions, being able to cast a vision and reach goals.  How do you know where you are going if you can’t track what is going on with your business?  By keeping good records, you allow yourself to quickly determine how your business is doing at any particular moment.  After keeping good records for a while you will be able to notice trends in your business and work to take advantage of them or minimize their impact.  You cannot put your head in the sand and hope things take care of themselves.  They don’t.  You have to play an active role in knowing what is going on in your business.

2.  Prepare your financial statements

Most business owners would kind of like to know how much money they are making.  Regardless of the size of your business, you need to keep up with your income statement (commonly referred to as a Profit and Loss Statement by the IRS) so you know how much money you are making (or losing).  It is also important to have a balance sheet so you know about your companies assets and liabilities as well as your equity in the company.

3.  Identify Sources of Receipts

In other words – know who is paying you.  First you want to make sure you keep up with who has paid and who has not so you can collect your money.  But more than this, know who your best customers are is one of the secrets to success.

You know the old 80/20 rule?  20 percent of your customers provide 80 percent of your profit?  Some business may be more skewed than that – like 95/5.  Anyway, by knowing who those 20 percent of your customers are, you can treat them better, market to them more effectively and further strengthen your relationship with them.  This also lets you know which customers are just draining you so you can drop them or just spend significantly less time on them until they become more profitable.

You can also apply the 80/20 rule to sources of income when we are talking about just customers but revenue streams altogether.  For example, as an attorney, I keep up with the income I receive from my tax problem clients, family court clients, real estate clients, corporate clients, etc.  You can do this as well so you can determine if there are specific areas of your practice that are more profitable.

4.  Help prepare your tax returns

This may be one of the most important reasons to keep good records.  You need to accurately be able to determine what your business earned this year and how much you should have to pay in taxes to the government.  If you have no idea about your corporate finances, then I can guarantee that you are losing money and paying too much in taxes each year.

Keeping up with good records also helps you keep up with all of those deductible business expenses that you have all year long.  You definitely want to be able to take those off the top of your gross receipts otherwise you are going to be stuck with a huge tax bill.  But if you don’t keep track of them your accountant is not going to be able to manufacture the numbers out of thin air for you.

5.  Support items on your tax return

Here is where bad record keeping kills you.  You have just been audited by the IRS or your state taxing authority and they want to see your records for those transportation expenses, materials, advertising and more.  If you don’t have anything to prove what you spent, then you are straight out of luck.  The IRS will disallow all of your expenses that you can’t prove.  So, even if they know you had some transportation expenses, if you can’t prove them, they’re gone!

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    As many of my readers know, my boss (a practicing attorney for almost 30 years) took a leave of absence shortly after I began working for him.  That left me in charge of a caseload of over 225 cases varying from drafting simple wills, trying contested divorce issues, contract disputes, and of course representing people before the Internal Revenue Service.  Not to mention the other stresses of running a small business such as generating revenue, "selling" clients on using a young attorney when they were hoping to meet with an older, more experienced one, paying bills and making payroll each week, and managing my employees.  I am extremely glad that the "trial by fire" is over, but it pushed me to new limits in my personal and professional career that would have taken me years to reach otherwise. 

    As a result, I feel that I have several years of experience and I am very comfortable managing my office and staff.  Of course, it makes it easy when you have great people to work with.  It also gives me confidence that I could go out and start a law practice of my own and be successful very soon rather than the usual rule of 2-3 years before a practice becomes profitable.

    This August, my first son was born.  He is an inspiration and a joy.  I wish I was able to spend many more hours each day with him so I could watch him learn new things.  As my professional life was extremely busy, his birth made me reevaluate my priorities and the importance I place on many other things in my life.  While there is a long way to go, I hope that I will be a great dad and teach him how to prioritize his life. 

    I have really enjoyed writing this blog as well as the newspaper column that I write each week.  I hope that my writing opportunities will expand in the new year as well as many other personal and professional opportunities. 

It covers:

• The best blogging techniques.
• How to get traffic to your blog.
• How to turn your blog into money.

I’ll let you know what I think once I’ve had a chance to check it out. Meanwhile, go grab yours while it’s still free.

    I have heard this said another way in the past: people don’t care about how much you know until they know how much you care. 

    I believe that by showing your prospective clients that you are genuinely interested in them and helping them solve their problems you can build up your client base with great clients quicker than by tooting your own horn all the time.  I find this is pretty standard for all professionals – not just attorneys.  The feeling is that if I want someone to hire me, I need to tell them all of the great things about myself like how high I graduated in my undergraduate and law school classes, how many certifications or professional merits I have received, how many similar cases I’ve won, etc.  While this information is relevant and helps me to sell myself, what really sells the client is that you care enough to know what their problem is and that you know how to get in all of those personal highlights in a manner that shows them how it helps solve their problems rather than building up your ego in front of them. 

    How can you go about showing people how much you care?  Get involved in the community in similar areas that your law practice servcs.  This gives you an opportunity to speak to people in a non-threatening environment, without all of the formality of law books, suits and big desks, and just talk. 

    This thought goes against some advice I received in law school which was: "never have coffee with your clients."  I think the visiting attorney was trying to get through to us that we want our business relationships to remain business so we don’t internalize everything and take every set-back or loss personally.  I think there’s a way to show clients that your are genuinely interested in them and their problems without becoming so personally intertwined that we cannot focus on serving our clients.

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- Albert Einstein

I came across this quote recently while attending a legal conference. It immediately hit me how close to home this hits for a lot of my clients. All of my IRS tax resolution clients have a problem. Sometimes they have been dealing with the issues for years. I can see how many clients get stuck in these situations because they never change their level of consciousness. They never get past some of the initial issues – even when the IRS tells them no matter what excuse they have they will still be liable for the taxes, penalties, and interest.

Once you can raise your level of consciousness where you can get past seeing the problems exclusively and how they arose, and begin to look for solutions to the problems you can get to a place where you are ready to solve the problem.

Hopefully, as an attorney, I can assist my clients in raising their level of consciousness by providing them competent counsel, good legal advice and all of the information they require to get make a decision that will allow them to solve their problem.

Now when I think about that and compare it to my law practice, I see many similarities to Tim’s old job.  I have to work a lot of hours to make sure I get the work done, but also to stay informed, to stay on top of the law, and then to take care of the administrative office stuff.  I sure spend a lot more time at the office than I do at home.  When I think about how possible it would be to run a law firm working four hours per week, I have to admit that would be a daunting challenge – and nearly impossible.  While it may not be totally impossible, because, hopefully, you’re spending at least four hours each week meeting with prospective clients, but there are ways to increase your productivity, decrease amount of time spent on “junk” and get paid for providing your professional service and not based on how many hours you work to complete it. 

I recently read a blog post about “The 4-Hour Work Week” and another interesting series of posts about the perfect law practice over at the Lawyer Profit Systems blog.  It’s my goal moving forward in my practice to define my ideal practice and develop a way to make that fit my ideal lifestyle that I want rather than let it control me.  More on that to come.