Page 66 - Small Business Taxes

16:31 - 2-Feb-2023
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Fileid: … tions/p535/2022/a/xml/cycle01/source
The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.
insurance premiums, and any other prepaid ex- The benefit gained by making this election is
pense that creates an intangible asset. If you Not-for-Profit Activities that the IRS will not immediately question
pay an amount that creates an intangible asset, whether your activity is engaged in for profit.
then you must capitalize the amounts paid and Accordingly, it will not restrict your deductions.
begin to amortize the payment over the appro- If you do not carry on your business or invest- Rather, you will gain time to earn a profit in the
priate period. ment activity to make a profit, you cannot use a required number of years. If you show 3 (or 2)
However, you do not have to capitalize loss from the activity to offset other income. Ac- years of profit at the end of this period, your de-
amounts for creating an intangible asset if the tivities you do as a hobby, or mainly for sport or ductions are not limited under these rules. If you
right or benefit created does not extend beyond recreation, are often not entered into for profit. do not have 3 (or 2) years of profit, the limit can
the earlier of 12 months after the date that you The limit on not-for-profit losses applies to be applied retroactively to any year with a loss
first receive the right or benefit or the end of the individuals, partnerships, estates, trusts, and S in the 5-year (or 7-year) period.
tax year following the year in which you made corporations. It does not apply to corporations Filing Form 5213 automatically extends the
the advance payment. If you are a cash method other than S corporations. period of limitations on any year in the 5-year
taxpayer and your advance payment qualifies (or 7-year) period to 2 years after the due date
for this exception, then you can generally de- In determining whether you are carrying on of the tax return for the last year of the period.
duct the amount when paid. If you are an ac- an activity for profit, several factors are taken The period is extended only for deductions of
crual method taxpayer, you cannot deduct the into account. No one factor alone is decisive. the activity and any related deductions that
amount until the all-events test has been met Among the factors to consider are whether: might be affected.
and economic performance has occurred. • You carry on the activity in a businesslike You must file Form 5213 within 3 years
manner,
Example 1. In 2022, you sign a 10-year • The time and effort you put into the activity TIP after the due date of your tax return
lease and immediately pay your rent for the first indicate you intend to make it profitable, (determined without extensions) for the
3 years. Even though you paid the rent for • You depend on the income for your liveli- year in which you first carried on the activity, or,
2022, 2023, and 2024, you can only deduct the hood, if earlier, within 60 days after receiving written
rent for 2022 on your 2022 tax return. You can • Your losses are due to circumstances be- notice from the IRS proposing to disallow de-
deduct the rent for 2023 and 2024 on your tax yond your control (or are normal in the ductions attributable to the activity.
returns for those years. startup phase of your type of business),
• You change your methods of operation in Gross Income
Example 2. You are a cash method calen- an attempt to improve profitability,
dar year taxpayer. On December 1, 2022, you • You (or your advisors) have the knowledge Gross income from a not-for-profit activity in-
sign a 12-month lease, effective beginning Jan- needed to carry on the activity as a suc-
uary 1, 2023, and immediately pay your rent for cessful business, cludes the total of all gains from the sale, ex-
change, or other disposition of property, and all
the entire 12-month period that begins on Janu- • You were successful in making a profit in
ary 1, 2023. The right or benefit attributable to similar activities in the past, other gross receipts derived from the activity.
Gross income from the activity also includes
the payment neither extends more than 12 • The activity makes a profit in some years,
months beyond January 1, 2023 (the first day and capital gains and rents received for the use of
property that is held in connection with the ac-
that you are entitled to use the property) nor be- • You can expect to make a future profit from
yond the tax year ending December 31, 2023 the appreciation of the assets used in the tivity.
(the year following the year in which you made activity. You can determine gross income from any
the advance payment). Therefore, your prepay- not-for-profit activity by subtracting the cost of
ment does not have to be capitalized, and you Presumption of profit. An activity is pre- goods sold from your gross receipts. However,
can deduct the entire payment in the year you sumed carried on for profit if it produced a profit if you determine gross income by subtracting
pay it. in at least 3 of the last 5 tax years, including the cost of goods sold from gross receipts, you
current year. Activities that consist primarily of must do so consistently, and in a manner that
Contested liability. Under the cash method, breeding, training, showing, or racing horses follows generally accepted methods of account-
you can deduct a contested liability only in the are presumed carried on for profit if they pro- ing.
year you pay the liability. Under the accrual duced a profit in at least 2 of the last 7 tax
method, you can deduct contested liabilities years, including the current year. The activity Limit on Deductions
such as taxes (except foreign or U.S. posses- must be substantially the same for each year
sion income, war profits, and excess profits within this period. You have a profit when the You can no longer claim any miscella-
taxes) either in the tax year you pay the liability gross income from an activity exceeds the de- ! neous itemized deductions. Miscella-
(or transfer money or other property to satisfy ductions. CAUTION neous itemized deductions are those
the obligation) or in the tax year you settle the If a taxpayer dies before the end of the deductions that would have been subject to the
contest. However, to take the deduction in the 5-year (or 7-year) period, the “test” period ends 2%-of-adjusted-gross-income limitation. You
year of payment or transfer, you must meet cer- on the date of the taxpayer's death. can still claim certain expenses as itemized de-
tain conditions. See Regulations section If your business or investment activity ductions on Schedule A (Form 1040).
1.461-2. passes this 3- (or 2-) years-of-profit test, the
Related person. Under the accrual method of IRS will presume it is carried on for profit. This Deductions you can take for personal as
means the limits discussed here will not apply.
accounting, you generally deduct expenses You can take all your business deductions from well as for business activities are allowed in full.
For individuals, all nonbusiness deductions,
when you incur them, even if you have not yet the activity, even for the years that you have a
paid them. However, if you and the person you loss. You can rely on this presumption unless such as those for home mortgage interest,
taxes, and casualty losses, may also be deduc-
owe are related and that person uses the cash the IRS later shows it to be invalid.
method of accounting, you must pay the ex- ted. Deduct them on the appropriate lines of
Schedule A (Form 1040).
pense before you can deduct it. Your deduction Using the presumption later. If you are start-
is allowed when the amount is includible in in- ing an activity and do not have 3 (or 2) years For the limits that apply to home mortgage
come by the related cash method payee. For showing a profit, you can elect to have the pre- interest, see Pub. 936.
more information, see Related Persons in Pub. sumption made after you have the 5 (or 7) years Generally, you can deduct a casualty loss
538. of experience allowed by the test. on property you own for personal use only to
You can elect to do this by filing Form 5213. the extent each casualty loss is more than
Filing this form postpones any determination $100, and the total of all casualty losses ex-
that your activity is not carried on for profit until ceeds 10% of your adjusted gross income
5 (or 7) years have passed since you started (AGI). See Pub. 547 for more information on
the activity. casualty losses.
Chapter 1 Deducting Business Expenses Page 7