Contact UsIf IRS rules that taxpayer's sole proprietorship is a hobby business, will the IRS then go back to prior years, and disallow the expenses claimed for that business for those prior years?
Taxpayer has claimed losses five years in a row on Schedule C, and has used these losses to offset W-2 income from main job. This business has only existed for five years.
I am aware that the general rule at the IRS is that one is expected to show a profit three out of the past five years. I have also read in one of the IRS Pubs that the business will come under an automatic review to see if it is following this rule.
I have a colleague who is stating that the IRS will send a notice that the business has been ruled a hobby business, and that "from this day forward will be treated as one."
I am aware that the general rule at the IRS is that one is expected to show a profit three out of the past five years. I have also read in one of the IRS Pubs that the business will come under an automatic review to see if it is following this rule.
I have a colleague who is stating that the IRS will send a notice that the business has been ruled a hobby business, and that "from this day forward will be treated as one."
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Tax Professional Answers
Thomas Rex, CPA
The answer is that it depends. Generally the IRS has a 3 year statute of limitations to make changes to a return. That time is increased to 6 years if there is income omitted from your return greater than 25% of the gross income stated in your return.
There is no limit on how far the IRS can go back if the return was false, or there was a willful attempt to evade tax, or returns were never filed, or for other reasons cited in Code Section 6501. Again, generally the IRS only asks for the last 6 years of unfiled returns.
There are other factors besides 3 years of profits in a 5 (or 7) year period to prove a profit motive. These are cited in IRS Publication 535 for Business expenses.
You can also elect to postpone any determination that your activity is not carried on for profit until 5 (or 7) years have passed since you started the activity. You would do this by timely filing IRS form 5213. However, this will extend the statute of limitations to 2 years after the due date of the tax return for the last year of the period. The period is extended only for deductions of the activity and any related deductions that might be affected.
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358 weeks ago
There is no limit on how far the IRS can go back if the return was false, or there was a willful attempt to evade tax, or returns were never filed, or for other reasons cited in Code Section 6501. Again, generally the IRS only asks for the last 6 years of unfiled returns.
There are other factors besides 3 years of profits in a 5 (or 7) year period to prove a profit motive. These are cited in IRS Publication 535 for Business expenses.
You can also elect to postpone any determination that your activity is not carried on for profit until 5 (or 7) years have passed since you started the activity. You would do this by timely filing IRS form 5213. However, this will extend the statute of limitations to 2 years after the due date of the tax return for the last year of the period. The period is extended only for deductions of the activity and any related deductions that might be affected.