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Tax Tip: Extra Tax Savings With a Second Business

Posted: Jan. 29, 2013, 6:45 p.m. EST


By Mark E. Battersby

Thanks to today’s tough economy, more pet professionals are seeking additional sources of revenue. Whether to cash-in on a hobby, plan for retirement or merely keep their heads above water, it is not unusual for business owners or the self-employed to have a secondary revenue stream. Few realize, however, that with or without the extra income from this other endeavor, Uncle Sam stands ready to pick-up part of the expenses.

That’s right, Uncle Sam in the form of U.S. tax laws allows all taxable income from an activity to be offset or reduced using the activity’s expenses. If the activity—or even a hobby—is operated as a business, however, the tax laws permit even more expense deductions to the point where they offset wages, savings and investment income—and the tax bill on that income from other sources.

In a surprising number of cases, the IRS will accept the characterization of two or more undertakings as one activity unless the characterization is artificial or unreasonable. Thus, a pet supply retailer who begins offering grooming services is usually “expanding” an existing operation. Starting a kennel near the pet professional’s vacation home, however, might be stretching matters.

Dog walking as a second business
Although the ever-vigilant IRS is unlikely to challenge every multiple activity, there are three situations that every pet professional should be concerned about.

The first potential worry involves losses where an unrelated, money-losing operation is used to offset income from a profitable operation—or the losses from a hobby activity are used to offset business profits, self-employment income, wages, investment income or the like.

Another situation likely to attract the attention of the IRS involves a start-up operation. Expenses incurred in expanding an on-going business are, of course, currently deductible. However, expenses incurred in starting a new, unrelated business generally must be capitalized and amortized or written-off over 15 years. There is, of course, a special exception: The first $5,000 of expenses may be deducted if the total start-up expenses don’t exceed $50,000. Obviously, a significant write-off is available if it can be argued that the new operation is really an extension of the original business.

The final situation involves the “material participation” rules. The U.S.’s voluminous tax rules limit the deduction for losses from so-called “passive activities,” activities that involve the conduct of any trade or business in which the taxpayer does not materially participate. Generally, losses from passive activities may not be deducted from nonpassive income (for example, wages, interest or dividends).

The IRS can both tax and help underwrite an activity, be it a hobby or part-time endeavor, a start-up business or a money-losing expansion of the business. On the one hand, it stands ready to tax all of the activity’s income. However, many of the activity’s expenses may be used to offset “hobby” income. Operate the activity as a “business”  and the amount by which the activity’s expenses exceed its income, the “losses,” can be used to offset income from other sources. Is your activity a tax business? 

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