Nolo's Small Business Legal Blog

One of the most powerful weapons in the IRS arsenal is the hobby loss rule. Under this rule, only taxpayers engaged in a bona fide business--as opposed to a hobby--can take business deductions. This means you need to be regularly engaged in an activity and your primary purpose must be to earn a profit. You don't have to show you earn a profit every year. But making a profit must be your primary purpose. Your business can be full time or part time, as long as you work at it regularly and continuously. In contrast, if the IRS decides that you are indulging a hobby rather than operating a business, you will face some potentially disastrous tax consequences. You may still be able to deduct some of your hobby-related expenses but there are serious restrictions and limitations on these deductions.

The IRS has established two tests to determine whether someone is in business. One is a simple mechanical test that looks at whether you have earned a profit in three of the last five years. The other is a more complex test designed to determine whether you act like a business. Under this test, the IRS looks at certain objective factors to determine whether you are behaving like a person who wants to earn a profit. The most important of these are that you act like you're running a business, you have a certain amount of expertise in the area, and you spend sufficient time and effort on the activity.

For more information, see Home Business Tax Deductions; Keep What You Earn, by Stephen Fishman (Nolo).

To make sure employers play their part in ensuring more workers get health insurance coverage, the new health care law contains a combination of incentives for smaller businesses and penalties for larger businesses. Here's an overview of the main provisions that will impact businesses, as reported by Rhonda Abrams in an article in USA Today called "The good and bad in health care reform for small businesses."

Tax Credit. Small businesses with 25 or fewer employees and $50,000 or less in annual average salaries can receive a tax credit for providing health insurance for employees. For 2010 through 2013, the credit will be up to 35% of the health care premiums the company pays for its employees each tax year. The credit will go up to 50% in 2014 provided the company buys its insurance through the new small business health insurance exchanges that will begin operating in 2014.

 

Penalties. Starting in 2014, businesses with more than 50 employees that don't offer affordable health care options for employees would be subject to a penalty. However, according to a blog on health care reform posted by Robb Mandelbaum in the New York  Times, as bad as this may sound, it won't really affect many businesses because "Ninety-six percent of businesses in the country with more than 50 employees offer health insurance (according to the Kaiser Family Foundation). . . .And 95 percent of the 28 million small businesses in America have fewer than 50 employees."

 

Health Care Exchanges. Starting in 2014, Small Business Health Options Programs - or SHOP exchanges - will be established. Through these exchanges, small companies with 100 or fewer employees will be able to pool their resources so they have greater buying power. This could result in tremendous savings for these small businesses. Also acording to Robb Mandelbaum of the New York Times, supporters of health care reform legislation predict that health costs for small businesses will drop by 20 to 30% and the current inequity between what small and big businesses pay for health care will be lessened.

The IRS recently extended--for the second time--a moratorium on collecting penalties for failing to report certain transactions considered tax shelters by the IRS. Caught in the IRS tax shelter snare are small business owners who paid into certain retirement accounts (namely 412(i) and 419(e) plans), even though the provision was intended to go after big corporation and wealthy individuals. As reported by Margaret Collins in a recent Business Week article, the IRS moratorium will suspend penalties on individuals who received less than $100,000 in savings from the unreported transactions and under $200,000 for other taxpayers. "Some of these businesses were assessed tax penalties as high as $300,000 per year but received a tax benefit for as little as $15,000 from the transaction," according to Senator Charles Grassley, an Iowa Republican. There is proposed legislation that would make the penalty proportional to the tax benefit received.

In an effort to stimulate hiring and increase employment, the Obama administration has proposed a one-year tax credit for businesses that hire new employees in 2010. Under the proposal, any firm that hires a new employee in 2010 would get up to a $5,000 tax credit for each hire. The credit is capped at $500,000 per company. In addition, firms that hire new employees or increase salaries of current employees would be reimbursed for Social Security taxes related to their increased payroll. The Social Security reimbursement would not apply to wages above the $106,800 Social Security maximum to make sure the benefit is tied to -- and encourages the hiring of -- less highly paid workers.

The administration estimates 1 million small businesses will take advantage of the credit, which is expected to cost the government $33 billion. The money would come from savings from the Troubled Asset Relief Program, which officials now think will cost $200 billion less than expected.  

New credit card rules designed to protect consumers from overreaching practices by credit card companies take effect on February 22^nd. These new rules, however, apply only to consumers--they do not cover credit cards issued to small business owners. So small businesses that carry credit card debt won't benefit from the new credit card rules unless they start charging business expenses on their personal credit cards. But, as noted by Emily Maltby in "Entrepreneurs Weigh Credit-Card Options,"while this may sound tempting, it's probably not a good idea. First, the new rules are intended to protect consumers, not businesses--they may not cover a personal credit card that is used too much for business purposes. Also, one of the first things most business owners do when they get started is to separate personal and business spending and expenses for tax and other reasons. Going back on this basic good business practice is not a good idea. 

Prior to last March, SBA loans could be used to guarantee any amount of goodwill included in the purchase price of a small business. With certain business purchases, the value of goodwill (name recognition and customer loyalty) can be as high as 55% to 95% of the overall purchase price. Starting in March of 2009, however, the SBA placed a cap on the amount of financing for goodwill that it would guarantee--$250,000 or 50% of the loan amount, whichever was lower. The new rules were meant to prevent sellers from overvaluing their company's goodwill or intangible assets.

The changes resulted in a tightening of capital and a 33% drop in business acquisitions from the prior year. As reported in a Wall Street Journal article, "It was the antistimulus." After a study finding that $400,000 was the average for goodwill financings, the SBA decided to raise the cap to $500,000 starting in October. Under its new guidelines, the SBA also recommends 25% in equity from the purchaser in goodwill financings over $500,000. Hopefully, the new rules offer a reasonable compromise between unlimited financing for goodwill (which can cause problems for purchasers) and overly restrictive terms that inhibit business acquisitions.

 

 

The stimulus package contains several provisions aimed at helping small businesses. The higher Section 179 deduction limit of $250,000 that was passed in 2008 is extended another year, as is the 50% first-year bonus depreciation from 2008. Also, businesses with net operating losses in 2008 can carry those losses back for the prior five years, to get a refund against old taxes paid. And another tax measure provides that the amount of estimated taxes that has to be paid by small business owners is now just 90% of the previous year's taxes (rather than the 110% most small business owners had to pay last year). Lastly, the stimulus package provides $730 million to the Small Business Administration's loan program, which should stimulate small business bank loans and nonprofit microloans to small businesses. For more information on all of these, as well as a few other provisions in the stimulus package not mentioned here, see Nolo's new article on How the Stimulus Package of 2009 Can Help Your Small Business.