Tax Audits

Once again my wife chose another tax account to prepare our taxes. My wife has her own graphics design business working out of our home. We have a small rental property in another state and two daughters that I spend a lot of my time with racing go-karts. We spend around 5K every year, maybe a tad more, on the karts and traveling. This year again, I presented our costs to the accountant for racing, and once again I was shot out of the sky like a clay pigeon at metro gun club. What gives? We have all the documentation, stickers on the karts and trailer, but “ you don’t want to draw attention from the IRS” or “this might throw up a red flag”. Lord help me, does the IRS go after everyone like this? Has anyone else been audited by the IRS and slapped down for sponsoring themselves or family? With all the great tax news coming from our capital, I wouldn’t mine for once just getting one dollar refunded to me. Thanks

The IRS could see your racing as recreational. Are you racing for profit? If so, I would form an LLC for the racing and file a schedule C with your 1044. You can claim a loss the first three years without a “red flag” after that, your going to need to show some type of profit or the red flag will be raised again.

This advise was given to me by my accountant. He told me people claim deductions like this all the time without doing it properly and your taking a gamble.

Consult with your tax person or get advice from a tax lawyer.

Derek is right. You could file the go cart “business” for 3 years before the IRS would maybe consider it a “hobby” instead of a business and tell you no more claiming the looses from it. Of course if you showed a profit within those three years (or on the forth year) they might still keep an eye on you, but you would have a better chance.

Sounds like your accountant is saving himself work in the long run incase you did get audited or red flagged.

If you have any other questions let me know. I run a small business tax service / consulting company on the side.

I will also add that the IRS is cracking down on more small business folks like your go carts, because SOME folks are abusing the system. It sounds like your deal is legit.

Depending on the size of your wife’s business you could maybe have her business sponsor the boys as a form of advertising. She could then use the deduction for advertising/marketing.

look at the other side of the coin, if your spouse has her business logos all over the go-carts can some “donations” be considered advertising to the self employment business? Is this the sponsorship you are referring to? I’m sure your wife already has 1099’s to file. I have bought a few tires for a stock car racing friend of mine, he had my business logo put on the sides of the car, took a picture. I claimed this as an advertising expense. He crashed and totaled his car the second race in, so I’d consider that a poor return on my investment. I know there are accountants out there who seem to work more for the IRS than they do you. There are some out there who will represent you and your best interests, keep looking.

No offense to the previous 2 posts here…but they are not correct. There is no “3 year rule” anywhere in the tax code. That being said, there are court rulings, etc that have indicated that 1 year of profit out of 3 (or 5 depending on the case) will satisfy the “profit-motive” requirement for a business. That does not mean you will not be selected for audit, nor does it mean your “business” will not be reclassified as a hobby. There are other tests that must be met to constitute a business.

For example, do you have any income from racing or just expenses? Do you have a business plan? Do you keep a set of books or just all the receipts? Have you changed your “business” operations to attempt to make a profit or are you still operating the same way and still losing money? Although this list is not all inclusive by any means, it is a start…especially the first one. If you do not have any income at all but you take all the expenses, you could just call the IRS and ask them to send an auditor out right away, and you may want to contact a tax attorney that specializes in fraud cases.

You may want to talk with the accountant/preparer to see what they suggest you do differently to make this a bonified business. If they are just not willing to show the business because “it will raise flags” you may want to find a new preparer. However, if there are other concerns, have them explain that to you.

JD

jd318 I do agree that there is NO WRITTEN 3 year rule, but it’s one of those unwritten rules that accountants have grown to love over the years. I have talked with professors, IRS agents, other accountants on this issue.

You do give some great pointers in the business plan, etc that would show he was more of a business, trying to profit. I encourage all my new clients that “want to start a business” to complete a business plan, register a business, etc before they even attempt to “open the doors”.

JD is right there is no “go ahead and lose money for 3 years” rule. I have guiding clients who run tourneys who were audited the second year in. I have other self employed clients who have not shown a profit on paper for 6 years. Big brother shows no special favors when a flag comes up.

Its not a tax code rule, its a small business rule. The IRS does not expect a new small business to turn a profit for the first 3-5 years.

Thanks, I don’t want the racing to be a business, it will never bring in a dime. My wife’s business is advertised all over them and I guess I’m looking for her to right it off. That must be the confusion that I’m having. Maybe the accountant doesn’t see it as a right off for her business.

Apparently we misunderstood your original question. If I am understanding correctly, you want to write off the expenses as advertising on your wife’s business? I would say you would have legitimate advertising expense for the actual advertising on the kart. The expenses for the karts, travel, etc. however, are probably correctly classified as a hobby.

If you ask me you have a legitimate write off for your wife. I don’t understand why your accountant didn’t consider this.

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My wife’s business is advertised all over them and I guess I’m looking for her to right it off. That must be the confusion that I’m having. Maybe the accountant doesn’t see it as a right off for her business.

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My wife’s business is advertised all over them and I guess I’m looking for her to right it off.

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If this is advertising, you will want to be able to make a convincing arguement that you have a reasonable expectation of receiving more income as a result of new business being brought in by people seeing this advertising. That is the whole purpose of advertising, and no business would invest money in an advertising campaign where they did NOT expect to get new customers and/or increase your income from your existing customer base. Make sure your accountant understands you are not trying to write off the expenses of your travel and your cart racing, as that would be considered a hobby.

As for your question about the IRS going after things like this, trust me, they do. I know a few people who were audited, one of them being a dance aerobic instructor. The IRS wanted to dis-allow her work-clothes as a deduction, since his opinion was they could be worn as street clothes. He only relented on that when he saw some of the work-out clothes instructors wear.

I also got to talk with an IRS auditor myself once, who personally looks for people who win money in fishing tournaments, and then writes off their expenses as a business instead of as a hobby. To prove to him it was a business, he wanted to see that at least 20% of the persons income came from fishing.

Well said das_bass.

I’ve represented clients before the IRS on numerous occasions. I know current and former agents and speak with them on business related items quite often. The IRS does audit these issues. Granted the number of audits is considerably lower the past 5-7 years, but my feeling is the auditors will “make it worthwhile” on the audits that are done.

JD

You need to put a price or value to the advertising. Call around and see what other forms of advertising cost. Se what it cost to advertise on a bus or a cab. Put some type of value to it. The thing is who are you paying for the advertising. Suddenly your cart hobby has an income. You can bet uncle sam will want to collect on that. So everything will even out in the long run. As far as writing off an advertising expense all I would consider claiming is the acuall cost for the graphics. Anything above that become an income somewhere else.

Jason