If you have a small business and you want to deduct your expenses, the IRS says you must be able to show that you are engaged in a trade or business for profit.
But that doesn’t mean your business has to be profitable every year.
If you can show that you are trying to make a profit, and prove it to the IRS’s satisfaction, you can deduct your expenses even if they exceed your business income.
If on the other hand, the IRS determines that your so-called business is really a hobby, you will be able to deduct expenses only to the extent that you have income from your hobby.
How can you prove that your business is really a business?
One way, say the IRS, it to make a profit in two out of five consecutive years.
But even if your business loses money each year, all is not lost, You can deduct your losses if you can prove that your intention was to make a profit, even though you failed to do so.
The Tax Court has found in favor of a taxpayer where the taxpayer had significant expertise in business, approached the activity in a businesslike manner, maintained adequate books and records, advertised the business, and changed the method of operation to increase profitability.
The more business-like your operation, the better you are poised to make a profit. And even if you don’t, the more likely you are to be able to deduct your losses. Good business practices make sense.