Horses Magazine Feature Finances LETTER FROM THE DARK SIDE
How Have You Conducted Your Business?
By Jacob R. Strecker, MBA, CPA
This is the fourth in a series of articles about what you need to know to survive an audit by the Internal Revenue Service. The third article discussed when the not-for-profit rules of Code Section 183 apply to your business. You learned how to prevent the Internal Revenue Service from gaining an advantage by splitting your business into multiple activities. Finally, passing or fail- ing the presumptive test was shown to have little impact on your status as a business. This article will begin our examination of the
nine factors that determine the existence of profit motive. The first factor will be looked at in this article. We have a lot of material to cover. So let’s begin. The first factor addresses the manner in which
you carry on your activity. Did you conduct your activity in a businesslike manner? You must be able to prove your actions were businesslike. The Internal Revenue Service will ask several
questions related to this first factor. Some of the questions will be easy and straight forward. Some of the questions will be difficult and complex. Ev- ery question involves something a business would do. The remainder of this article presents these questions. Did you register the name of your business? While not required when you operate your busi- ness under your own name, it is better to select another name and register it with the appropriate government agency. The name of your business has value that increases with your success. Busi- nesses register their names to protect this value. Do you have a separate bank account for your
business? Businesses do not operate out of their owners’ personal bank accounts. While good rea- sons can be given for not having a separate bank account, it is much better for you to be able to answer yes to this question. You should have a separate bank account for your business. Do you have separate accounting records for
your business? The key word is separate. Your accounting records do not have to be complex. It does not matter whether your records are gener- ated manually or through the use of a computer. You need to be able to prove your accounting re- cords are: 1) Timely prepared 2) Independent of personal transactions
3) Reviewed on a regular basis 4) Used to make business decisions 5) Sufficient to prepare an accurate tax return Were all of the required registrations and fil- ings related to your business done on a timely basis? While the types of registrations and fil- ings vary by business, the issuing of W-2’s and 1099’s are common to most. Businesses issue all required
W-2’s and 1099’s. What investigation did you do, prior to starting
your business, to determine that you could expect to make a profit? The following are some of the ways this research could have been performed: 1) Reading publications 2) Discussions with other business owners 3) Discussions with trainers, vets, etc. 4) Visiting farms 5) Attending shows, races and competitions 6) Attending sales events 7) Attending classes, clinics and seminars You have to be able to show how the results of
this research resulted in your expectation of being profitable.
Did you prepare a written business plan prior to starting your business? Your plan shows how you were going to make a profit.
You must be able to prove that you had a plan. While it is better to have a written plan, you can still have a plan without it being in writing. Did you prepare a written profit projection
prior to starting your business? Your projection proves that a profit could be achieved by follow- ing your plan. The projection also shows that you were aware of the income and expenses that would be generated once your business started. The projection should include: 1) The amount of expected income 2) The amount of expected expenses 3) The amount of expected profit 4) The number of years required to be profitable
5) The number of horses required to be profitable
Again, it is better to have a written projection; however, you can still have a projection without it being in writing. Did you review your business plan and profit projection and adjust each of them for the results of the prior year? Business plans and projections are a continuing process and need to be updated
42 • Horses Magazine • July 2012 • Download and View FREE on-line at
www.horsesmagazine.com
annually to reflect the changes that have taken place in your business. The Internal Revenue Service will argue an out of date business plan and profit projection are proof that you do not care about making a profit. Due to the speculative nature of horse busi-
nesses, plans and projections are difficult to pre- pare. However, the Internal Revenue Service still expects you to have a written business plan and profit projection. Keep in mind, a written plan and projection are the best proof that you expect to make a profit. A later article in this series will give some insight into how to prepare a business plan and profit projection for your horse business. What steps did you take to terminate unprofit- able activities? You need to be able to prove that you made changes to increase income and reduce expenses. Steps taken to increase income are the most important. You can reduce your expenses to zero and still not make a profit if you do not have income. Were your actions consistent with your busi-
ness plan? The type, number and use of your horses have to follow your plan. Remember, your plan shows how you expect to achieve a profit. Not following your plan is an indication that you do not really care about making a profit. Did you evaluate the performance of your
horses? To be able to make this evaluation you need to set standards for each horse. You have to be able to prove that you are aware of what each horse needs to achieve for your business to be profitable. The steps you take to insure your horses meet these standards are important; how- ever, your reactions to horses not meeting these standards are critical. Horses need to be dis- posed of whenever it becomes apparent that they will not meet the standards necessary for your business to be profitable. The Internal Revenue Service cannot be left with the impression your horses are family members. (Author’s note: I am only the messenger.) Did you advertise and promote your business?
You need to be able to document the types and dollar amounts associated with your advertising and promotion. Your business can be advertised through the use of publications, flyers and the internet. However, the success of your horses at shows, races and competitions has the greatest promotional value. This usually has to be pointed out to the Internal Revenue Service. Advertis-
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