textfiles/law/taxother.tut

#help.tut PRESS ENTER FOR HELP
#define.stb Definitions of legal terms
#183.sta Internal Revenue Regulations, tax losses
TAX DEDUCTIBILITY OF BBS OPERATIONS

There are 3 subjects regarding taxes and BBS systems. These 
cover:

a) deduction of BBS expenses when the BBS is not the sole 
activity (deduction of BBS expenses by a business which does not 
have running a BBS as its primary activity);

b) deduction of tax losses, BBS as sole activity, including 
determination if a BBS is run for profit or is a hobby;
and

c) general rules for BBS accounting, including depreciation and 
other tax preparation and planning.

This tutorial covers a and b. Topic c will be issued in an 
update.

In the world of tax law there are fewer constants than in other 
areas of law. Accordingly, our staff, in consultation with 
C.P.A's and after review of I.R.S. regulations have prepared 
these tutorials. However, the resolution of tax disputes are 
usually made "in due consideration of all the facts and 
circumstances" which is a polite way of saying that anything can 
change the outcome, and these determinations are made on a case 
by case basis.

Tutorial (a)- Deduction of BBS expenses when the BBS is not the 
sole activity.

Most software houses have multi--line BBS systems for support, for 
distribution of upgrades and even for taking orders on line. In 
this case, deduction of the expenses related to operating the BBS 
system are simply ordinary business expenses and can be 
characterized either as part of support expense, part of sales of 
expense or even part of the cost of goods sold.

What about someone who is engaged a trade or business that is not 
directly related to computers? Let's take as a test case, a 
florist. If the florist operates a BBS, the expenses incurred in 
operating the BBS, provided that it is a bona fide attempt to 
publicize the business or to take orders is properly deductible 
as an expense of the business.

This rule would apply even if the BBS traffic is not all or even 
mainly directly to the floral business. However, it is 
recommended that the availability of order by BBS be included in 
sales literature and other advertisements.

DEDUCTION OF LOSSES- BBS as sole activity

Whether running a BBS as full time job, or, as an after work 
activity, costs of long distance to gather echo mail, doors etc. 
can cause a loss from operations. Many BBS systems that are now 
Super Systems with 50, 100 or more lines were unprofitable, 
struggling for acceptance and user dollars.

Since many BBS systems lose at the start of their operation (as 
do most businesses in their initial phases) the IRS has provided 
two different yard sticks as general rules for individuals and 
Small Business (Sub S) corporations. These are:

1) Presumption that activity is for profit, and thus, losses are 
deductible. The activity will be presumptively for profit if in 
the past 5 years, the GROSS INCOME of the activity exceeds the 
deduction attributable to the activity in any three of the years. 
A rarely used provision allows an election that the presumptive 
period be extended. However, it is strongly recommended that 
parties do not use this election, since it effectively "flags" 
the taxpayer's concerns over the propriety of the deduction.

Many persons think that this is the exclusive test. In fact, it 
is not. In many reported decisions activities which have had much 
longer records of losses have been found to be businesses engaged 
in for profit. Even if a taxpayer meets this presumption, the 
Internal Revenue Service is still entitled to attempt to rebut 
it. In fact, the "objective test" stated below is far more 
descriptive of the actual determinations which are made by the 
IRS in case of disputes of the deductions. The fact is that many 
businesses fail, or, have long periods of losses before 
establishing a market niche and a profit.

In most cases, the IRS uses the objective test.

2) "Objective test" based on nine factors:

1) The manner in which the taxpayer carries on the activity;
2) The expertise of the taxpayer or his advisors;
3) The time and effort expended by the taxpayer in carrying on 
the activities;
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 amounts of occasional profits, if any, which are earned;
8) The financial status of the taxpayer; and,
9) Elements of personal pleasure or recreation.

The objective test is not based solely on the nine factors stated 
above and the regulations (which are reproduced in full, and can 
be read on screen by using the "S" option) specifically provide 
that any other relevant factors may be considered by the IRS. 
Some of the other facts that are considered are the statements of 
intent made by the taxpayer and the tax sheltering affect of the 
investment. In addition, the financing terms 

The test considers the actions of the taxpayer as a whole. One or 
more factors may be conclusive.

The regulations discuss the nine factors in detail.

Factor one is the behavior of the taxpayer. Keeping business like 
records is important, as is objective signs that it is a business 
rather than a hobby. For example, having a separate business 
account, a business license and paying business rates for phones, 
etc. are strong indications that a BBS system is being operated 
in a business like manner. This may cause some difficulties since 
in many cases, the BBS system is operated out of a person's 
residence, and it may not be possible to obtain a business 
license if the area is not zoned for office use.

If the business experiences a loss, changes in operations to try 
to make a profit are important.

Factor two is the expertise of the taxpayer or advisors. In most 
cases this factor will be immaterial to the consideration of BBS 
related businesses, since the person establishing the BBS almost 
always is a "power user" of DOS and educates himself about 
telecommunications. This factor usually is invoked only when a 
taxpayer goes into farming and has no experience in farming and 
does not employ a trained manager.

Factor three is the time and effort expended by the taxpayer. For 
example, if a taxpayer resigns his job and works full time on a 
BBS a profit motive will be found, with the exception that 
someone with a huge income from investments who works 40 hours a 
week on a BBS in a haphazard fashion may not be found to have a 
profit motive.

However, full time activity is not needed. The time must be 
commensurate with the economic value of the enterprise. If 
employees or partners are involved, less time by the taxpayer is 
required.

Factor four, expectation of appreciation of the property should 
be inapplicable since computer equipment is notorious for  
quickly depreciating in value since the technology improves 
rapidly.

Factor five is the "taxpayers success in other activities." This 
factor gives recognition to the fact that certain business 
persons have the ability to turn around losing propositions. 
Accordingly, such taxpayers are given more latitude. However, the 
mere fact that a taxpayer has never been involved in a similar 
business is not proof that the taxpayer lacks a profit motive.

The sixth factor is the profitability of the venture. 
Suprisingly, if a business makes a profit it is more likely that 
it is intended to make a profit than one which does not! (The 
Tautology department to the assistance.) There is some small 
degree of actual meaning in this section. If a business is 
continued for a period of much longer with losses than usual, the 
IRS may come to the determination that the activity is not 
engaged in for profit.

The regulations also refer to such esoteric ideas as the 
relationship between receipts and disbursements is a separate 
consideration from profitability. (No, this is not bad comedy 
writing.)

However, the regulations do refer to the fact that if losses are 
caused by unexpected circumstances such as theft, depressed or 
saturated markets the losses do not necessarily disprove profit 
motivation.

Factor seven considers the amount of profit in relationship to 
losses and investments. Thus, a small profit if totally 
outweighed by losses, or, profits that are indicative of a 
terrible return on investment may indicate that the businesses is 
not truly engaged in for profit.

However, if there are any years with large profits, ordinarily 
this is conculsive proof that the activity is engaged in for 
profit.

The penultimate factor is the financial resources of the 
taxpayer. For example, if the taxpayer does not have substantial 
assets, this is taken to indicate that a profit is necessary in 
order to survive, and, thus the business activity of the taxpayer 
is geared to earn a profit.

However, if a taxpayer is wealthy and engages in a continuing 
stream of losses then in most instances would torpedo someone who 
is not wealthy, then the losses are likely to be found a "hobby" 
rather than a business loss.

The last factor is the element of personal pleasure or recreation 
in the activity. Exotic activities which are not conducted in a 
business like fashion will in most instances be determined to be 
a hobby. The regulations spend a great deal of time discussing 
horse racing, pointing out such obvious circumstances that those 
who act as if they do not care whether they make money or not, 
and only race at "prestigious" events and go to parties they are 
not in it for a loss. The point here is that you do not have to 
suffer but it needs to look like work!