(MONEY Magazine) -- I saw a website that claims I can lower my taxes by declaring my blog as a business for tax purposes. Is this really possible? -- A.K., Los Angeles, Calif.
Sure, it's possible.
But if you're planning to slash your tax bill by taking big deductions for costs you attribute to your blog You'll want to be sure you can make a solid case for it before you file your taxes.
Otherwise, you could find yourself in hot water with the IRS.
Here's the deal: If you run your blog, or for that matter any other activity, as a profit-making venture, you're entitled to deduct what the IRS calls "ordinary and necessary" business expenses from the income your blog generates.
Those expenses could include the fees you pay to set up and maintain your blog, research and administrative costs, the expenses involved in operating an office in or outside your home -- even depreciation of electronic equipment and travel, as long as they have a bona fide business purpose.
For example, if advertising on your blog produced $5,000 of revenue last year and your business expenses totaled $2,000, you would show $3,000 of taxable income from your blog, most likely by filing IRS form Schedule C. You would then report that $3,000 of taxable income along with any other income on IRS form 1040.
In that case, your blog would boost your taxable income, although you could reduce the tax hit from that extra income by contributing to a tax-deferred savings plan designed for the self-employed, such as a SEP-IRA, or an IRA, if you qualify.
Things get tricky if your expenses exceed the income from your blog.
Let's say that you report $5,000 of income and $25,000 in expenses for a loss of $20,000. If you also had, say, $70,000 of income from a job, your $20,000 loss would reduce your reported income to $50,000. Assuming a 25% marginal tax rate, that loss would shave $5,000 from your federal tax bill.
While that may be sweet from your point of view, the IRS might wonder whether you're actually just trying to game the tax system by taking deductions for what is really a hobby rather than a business. Which means that if you expect to report losses from your blog and use those losses to lower your taxes, you'd better be prepared to demonstrate your blog is a business and not a hobby.
How can you do that? One way is to meet the "profit" or "three of five test." The IRS presumes that "an activity is carried on for profit it if makes a profit during at least three of the last five tax years."
Failing that test doesn't automatically relegate your blog to hobby status. The IRS also considers other factors, such as whether you depend on income from the activity, have the expertise to run the venture and are putting in the effort to make the business successful. You can also bolster your case if you operate in a business-like manner, keeping good books and records and looking for ways to improve profitability.
Essentially this is a judgment call. The more often you make a profit and the more you run your blog like a real business, the more likely the IRS will recognize it as one. If you're always racking up losses and operate in a helter-skelter way, you'll have a harder time making a case.
If you file your taxes on the assumption that your blog is a business and the IRS ends up declaring it a hobby, you can still deduct the expenses you incur for your blog. But you can deduct them only up to the amount of income the blog generates -- and doing even that may be difficult because certain expenses can be written off only to the extent they exceed 2% of your adjusted gross income.
In short, those limits would rule out using a loss from your blog to lower the tax bill on your other income.
One final note: Even if you do establish your blog as a business, you should know that the IRS is also aware that some people like to shift personal expenses to their businesses to reduce their tax tab. And the IRS doesn't hesitate to audit people it suspects of crossing that line.
So if you're thinking about deducting that $10,000 home-theater system you had installed in your family room last year on the theory that HD and surround sound are crucial to your ability to blog about the presidential election campaign, I'd reconsider.
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