Trenthams and McGills put together a business and funded a bank account. The boys received a small salary. They acquired six whippets for breeding and started to pay for feed, equipment, veterinarians and the like.
The breeding business was not lucrative. In fact, it brought in just one sale, and plenty of annual losses. The whippets did not respond to Bobo and Morton’s unfocused, unscientific breeding attempts. When a friend said he used the soulful music of Barry White to set the mood, the boys tried that with the whippets. When Barry White didn’t work they went on to the next half-hearted attempt at breeding.
Whenever they got the chance, the dogs would run away. While there was no way chunky Bobo could ever catch them, neither could spry Morton. The whippets were born to run, and run they did.
As dogs disappeared, their parents, somewhat strangely, and without question, approved the purchase of more whippets. This went on for over two years until two very dramatic things happened.
First, the County Sheriff, John Law, showed up at the kennel with a complaint. The runaway whippets were doing something they never did for Bobo and Morton-they were breeding. There was now a large pack of wild whippets roaming the county. They were knocking over garbage cans and cruelly taunting the authorities with their speed. Sheriff Law made it clear, in a very loud and angry voice, that he did not like to be cruelly taunted. He inquired where their dog breeding, health permit and city business licenses were located. When Bobo said he didn’t know if they had any of that, Sheriff Law handed him an order to shut down the kennel. He departed in an official huff leaving the main gate ajar. Before Sheriff Law took five steps to his black and white patrol car, six whippets were out the gate and sprinting off into the countryside.
That same day, the boys’ parents received a certified letter from the IRS. They were being audited on the dog breeding business. Because the parents had been writing off significant losses (and receiving a tax break for the losses) while no real income had been generated, they were subject to hobby loss rules.
The parents brought in their attorneys and CPAs to deal with the sheriff and the IRS. There were fines and penalties to pay on both fronts. One of the CPA’s assistants who knew Bobo and Morton found the whole situation hilarious. He dubbed them the ‘Hobby Loss Twins’ which, to Bobo and Morton’s chagrin and anger, made the rounds around town.
And with their dog breeding business suddenly shut down, Bobo and Morton needed to find something new to do...
Hobby Loss Rules
When getting into business you must distinguish between a legitimate business and an activity that is considered a hobby or a business that is not at all profitable. The IRS has been targeting hobby losses for many years. Losses from hobbies cannot be written off against other income. Look at it from the IRS point of view. If you love breeding horses, and make no money at it, why should you get a write off? If your new business makes a profit, then you don’t have to worry about the hobby loss rules. On the other hand, if the new enterprise consistently generates losses (deductions exceed income), the IRS may step in and say it’s a hobby rather than a business.
There are two ways to avoid the hobby loss rules. The first way is to show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing, or racing horses). The second way is to run the venture in such a way as to show that you intend to make it profitable. The IRS regulations say the hobby loss rules won’t apply if the facts and circumstances show that you have a profit-making objective.
How can you prove that your objective is to make a profit? As a start, you can do so by running the new venture in a businesslike manner. More specifically, the IRS and the courts will
look to the following factors:
• how you run the activity.
• your expertise in the area (and your adviser’s expertise).
• the time and effort you expend in the enterprise.
• whether there’s an expectation that the assets used in the activity will rise in value.
• your success in carrying on other similar or dissimilar activities.
• your history of income or loss in the activity.
• the amount of occasional profits (if any) that are earned.
• your financial status; and whether the activity involves elements of personal pleasure or recreation.
The classic “hobby loss” situation involves a successful business person or professional who starts something like a horse ranch or a farm. But the IRS’s long arm also can reach out to more common situations, such as business people that start what appears to be a bone fide sideline business. Before starting your business speak to your CPA to make sure it is considered a legitimate business in the eyes of the IRS. While hobbies can be a source of relaxation and satisfaction we don’t want the IRS to deem your business that you work hard in to make successful a mere hobby. And as you are starting to realize right at the start you may need the help of...
Your Professional Team
Hiring professionals to do what they do best frees you up to do what you do best. And while you may not need all of them before you set up shop, it is not a bad idea to know who you will need and want on your team before the day-to-day demands of your business overwhelm you. Remember that corporate veil? Utilizing the expertise of the right professional team will help you make certain your business is complying with local and federal requirements. As an example, they’ll help you avoid the hobby loss rules.
You want a professional team on your side who understand your business and work well with you and with each other. You want professionals who can guide you through the startup phase and who can then assist you in growing and expanding your company, deal with contracts and customers, get your message out and protect your assets. The following are some (but not all) of the experts who make up the professional team.
Banker
Banks have a host of services for businesses of all sizes. Knowing a banker (not just a teller at the counter) at your business bank is important. A good banker on your team can provide you with ideas and programs for your growth.
Establishing a relationship with a local bank can help you network in your business community. And having a previously established relationship with a banker will help when you are ready for a business loan or line of credit. Bankers can keep you up to date with other financial products that might work for your business, from merchant banking services to having the bank put together your payroll system.
Ask to meet with a vice president or a private business banker. Get to know them and keep in touch. It can’t hurt to have a banker on your side. At the start, you will open a bank checking account for your business and get checks imprinted with your company name. Banks can also provide credit cards for your business, which is a great way to start building credit for your business for the day when you start looking for loans and other forms of financing.
Insurance Agents
At the start, shop your insurance needs around. Insurance rates can vary greatly and you don’t want to overpay.
