If you are in tax debt with the IRS there is a way you can negotiate with the IRS to settle the amount you owe for less. This IRS program that allows for this is called an offer in compromise. As an attorney, I have negotiated lots of these for my clients. However, I know that not everyone can afford an attorney, and some would just prefer to do it themselves so they are in complete control.
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We are continuing on through the Hobby vs. Business series and have come to the second of the factors used to determine whether your activity should be considered a business or a hobby and we remember that this determination could make a huge impact on your tax returns and what you will owe the government this year.
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.
I am frequently asked if you have a “small” business in your home do you have to pay taxes on what you earn. Of course, you have to pay taxes on your net gain. So that leads to the next question. What type of expenses can I write off in my business. The IRS regulates what expenses can be deducted from your business income to determine what the net profit is for a business. For a legitimate business you can deduct “ordinary and necessary expenses for conducting a trade or business.
For this post and probably a short series posts we are going to discuss what sets a legitimate business apart from a hobby.
There are several factors that are used by the IRS to determine what is a “business” and what is a “hobby.” The difference could mean whether you can deduct expenses on your tax return and for some people that may be a substantial amount of money you will owe Uncle Sam at the end of the year. These factors (listed below) are not all-inclusive and they are all weighed in the decision, stated another way - one factor does not determine the classification as hobby or business.
- Does the time and effort put into the activity indicate an intention to make a profit?
- Do you depend on the income from the activity?
- If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
- Have you changed your methods to improve profitability?
- Do you have the knowledge needed to carry on the activity as a successful business?
- Have you made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Do you expect to make a profit in the future from the appreciation of assets used in the activity?
With few exceptions, an activity is presumed a business if it has made a profit in at least three of the last five years. Follow along with me through this series to determine if that little “business” you have going on in your garage is truly a business or more of a hobby.
I receive a lot of referrals of clients from divorce attorneys in town seeking what they call innocent spouse relief. I have to admit, it sounds good! I mean, if your soon-to-be ex-spouse has agreed to pay all of the outstanding taxes then you should be an "innocent spouse," right? And recently, I have been talking with a lot of people with this type of case - or at least they think it is this type of case.
Actually, innocent spouse is not a good title for this type of relief at all because it gives many people lots of false hopes about their liability and their ability to get out of the taxes they owe because it is really only applicable in a few situations and only a handful of people actually qualify for the relief.
The most difficult of the requirements to qualify for this relief is that your spouse intentionally under-reported income to the IRS - meaning, your spouse did not list some of his or her income from last year. This is generally not the case. Nine times out of 10, I speak with a wife signed the joint income tax return with her husband and assumed he was going to take care of paying the taxes "because he always does." Other times, the spouse has agreed to be liable for the taxes in a divorce agreement. Most recently I was very disappointed to hear that an IRS employee advised my client (before she was my client) to go ahead and file joint tax returns for the back tax returns that had not been filed even though her husband was deceased. Now that is not inherently wrong, but in this case, the wife works for a church and makes a modest salary and has taxes withheld while the husband was self-employed and had made no tax payments during any of the last six or seven years. By filing these joint returns, she has now taken on this tax liability of her deceased husband and does not qualify for innocent spouse relief! (That is just wrong!!) However, none of these effect the IRS. You continue to be liable for the taxes that are due no matter what your spouse does.
If you are looking at tax problems because of your spouse (or for any other reason) I just want to let you know there are options and if you do not qualify for innocent spouse relief there are several other things that can be done to help you pay less than what the IRS says you owe. Read through the rest of this irs problems blog for information about offers in compromise, currently not-collectable status, and installment agreements for information about some of the ways you can resolve your tax problems with the IRS.
Recently, our firm gave a talk at the local Rotary Club here in Greenville, SC. After the session, one of the members who is a financial adviser to small businesses asked about a certain part of our presentation. Specifically, he wanted to know if business owners could really become personally liable for the taxes owed by the business.
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?
I met with a prospective client recently who was having their paycheck garnished by the IRS and didn’t know that it was coming. He was mad to say the least. Upon questioning him a little more, I found out that he had several years of unfiled income tax returns and had moved several times in the past three years.
The IRS is not required to track you down - though they probably could. The law just requires them to give you notice at your last known address and since he had moved several times since he filed his last tax return, the IRS obviously did not have his current address. If you have moved and haven’t updated your address recently you can send in the IRS Change of Address Form to make sure you receive notices from the IRS in the future.
Now, just because the IRS has started with a wage levy doesn’t mean that we have reached the end of the road. There are ways to get the wage levy reduced or stopped all-together. That’s for another post.