Dear Tax Talk:
I own a small wooden boat building business with my husband. We are in our fifth year of operation and while we have no debt, we have never shown a profit to offset my corporate income. I have heard that a business must show a profit every five years to be viable, but cannot find confirmation on that. Could you tell me what the law is?
-- Jennifer

Dear Jennifer,
A trade or business is generally an activity carried on to make a profit. The facts and circumstances of each case determine whether an activity is a trade or business. You do not need to actually make a profit to be in a trade or business, as long as you have a profit motive. You do need to make ongoing efforts to further the interests of your business. For example, a sporadic activity or a hobby does not qualify as a business.

The IRS will consider a loss activity not to be a hobby if in three of five tax years the activity generates a profit. If you fail this standard, an activity can still be considered a business with a profit motive depending on all the facts and circumstances. The determination whether an activity is engaged in for profit is to be made by reference to objective standards. Although a reasonable expectation of profit is not required, the facts and circumstances must indicate that the taxpayer entered into the activity, or continued the activity, with the objective of making a profit. In determining whether such an objective exists, it may be sufficient that there is a small chance of making a large profit.

The IRS, through the courts, has established nine relevant factors to be used in evaluating profit motive. The nine factors can be found in IRS Regs. Sec. 1.183-2. You can read the regulation by going to the IRS Web site and looking at Chapter 4.

9 factors for profit motive:

1. Manner in which the taxpayer carries on the activity. 2. The expertise of the taxpayer or his advisers. 3. The time and effort expended by the taxpayer in carrying on the activity. 4. Expectation that assets used in the activity may appreciate in value. 5. The success of the taxpayer in carrying on other similar or dissimilar activities. 6. The taxpayer's history of income or losses with respect to the activity. 7. The amount of occasional profits, if any, which are earned. 8. The financial status of the taxpayer. 9. Elements of personal pleasure or recreation.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

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