If you run a business, you know that you need to support expenses with detailed records. To be deductible, every expense on your tax return might have to be defended if your company is subject to an audit. Plus, failing to operate in a businesslike manner, complete with good records, might lead the IRS to deem the activity a hobby rather than a business — and your expenses may be limited or disallowed.
While there’s no one right way to keep business records, some types of expenses do require more details. For example, records relating to automobile expenses, travel, meals and office-at-home costs are subject to special requirements or limitations.
To Claim Deductions, an Activity Must Be Engaged in for Profit
For a business expense to be deductible, the taxpayer must establish that the primary objective of the activity is making a profit. The expense must also be substantiated and be an “ordinary and necessary” business expense. In one court case (Gaston v. IRS, 2021), a taxpayer claimed deductions that created a loss, which she used to shelter other income from tax.
She engaged in various activities that included acting in the entertainment industry and selling jewelry. The IRS found her activities were more like hobbies than businesses engaged in for-profit and it disallowed her deductions.
The taxpayer did, however, have some success when she took her case to the U.S. Tax Court. The court found that she was engaged in the business of acting for profit during the years at issue, though not all of the claimed expenses were ordinary and necessary business expenses. The court allowed deductions for expenses including headshots, casting agency fees, and lessons to enhance the taxpayer’s acting skills. But the court disallowed other deductions because it found insufficient evidence “to firmly establish a connection” between the expenses and the business.
In addition, the court found that the taxpayer didn’t prove that she engaged in her jewelry sales activity for profit. She didn’t operate it in a businesslike manner, spend sufficient time on it or seek out expertise in the jewelry industry. Therefore, all deductions related to that activity were disallowed.
We Can Help
Contact us if you need assistance retaining adequate business records. Taking a meticulous, proactive approach can protect your deductions and prevent the IRS from viewing your business as a hobby.
