October 17, 2009

Missions Work: "Business" or "Hobby"

Question:

A missionary receives little support and uses a lot of her own funds to cover her expenses. Can the expenses paid out of her personal funds be deducted as a business expense on Schedule C as well? If so, she will always have a substantial loss, as she funds the majority of her work with her personal funds.

Answer:

Business expenses can be deducted even if they lead to a loss in a particular year. But if an activity is classified as a hobby (not as a business), expenses can only be deducted to the extent of income. In other words, a business loss on Schedule C cannot be created.

According to IRS Publication 535 and related instructions on its website,

"Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit.

"In order to make this determination, taxpayers should consider the following factors:
Does the time and effort put into the activity indicate an intention to make a profit?
Does the taxpayer depend on income from the activity?
If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
Has the taxpayer changed methods of operation to improve profitability?
Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
Has the taxpayer made a profit in similar activities in the past?
Does the activity make a profit in some years?
Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?

"The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year."

In the question addressed above, my guess is that it is doubtful that her activity would be consider "for profit" unless it is only a rare year that income falls short of expenses. She should consider whether her excess expenses qualify for a charitable contribution deduction. For this determination, my posting earlier on this date may shed some light.

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