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Many people dream of making money pursuing a favorite hobby. By starting a sideline business, you could be eligible for a treasure chest of tax deductions.
Warning: The IRS and the U.S. Tax Court often denies losses if the taxpayers have no written business plans, don't do any advertising, and keep poor records.
If you follow certain rules, you can deduct the expenses related to your venture, including equipment, advertising, subscriptions and business-related auto costs.
You might even be able to claim a loss that can lower the tax you owe on wages, interest and dividends. Keep in mind, however, that "hobby losses" are a favorite target of the IRS. If the tax agency decides your endeavor is not a legitimate business, your deductions are limited to the income from the activity. At the same time, the IRS knows that it's not unusual for a business to operate at a loss in the first year or two.
With that background, here are five recommendations to help secure valuable deductions and stay out of hot water, but talk to your tax professional before going ahead:
Investigate. Do an extensive study of accepted business practices in the industry. Get training if you need it and keep copies of feasibility studies or expert opinions.
Keep separate accounts. Don't mingle personal and professional money in your bank accounts.
Operate professionally. Get business cards, stationery, a business telephone listing and advertise. Save receipts and document business expenses and the hours you spend on the venture.
Draw a business plan. Include income, expenses and an expected profit in the future. Make the plan for five or ten years.
Show a profit. The IRS usually leaves businesses alone if they show a profit in three out of five consecutive years (two out of seven for certain horse businesses). Timing is crucial so consider moving deductions and delaying business income so you can show a loss one year and a small profit the next.