The IRS and business plans
In recent years the IRS has ruled that a written business plan is important evidence which tends to prove that you are operating in a businesslike manner. The Tax Court has said that in hobby loss cases you should have “some type of plan” for the venture. This applies whether you are involved in livestock ranching, horse breeding, other farming activities, classic car refurbishing, antique collecting, boat or aircraft chartering, and other areas traditionally under IRS scrutiny.
The IRS takes the view that a written business plan demonstrates your businesslike concern for the success of the venture. People engaged in a hobby do not have business plans. One of the most important things that distinguishes a business from a hobby is the existence of a written business plan.
There are numerous resources, some good and others not, to assist you in drawing up a business plan. It is advisable to have a business plan drafted by a professional, and the fee will depend on the complexity of the facts involved.
Keep in mind that a business plan is one of the best items of evidence to show your true intentions. The IRS Audit Technique Guide asks revenue agents to ask for a business plan in horse and livestock audits, and the absence of a plan is evidence that the taxpayer is not operating in a businesslike manner. In audits, most individuals are caught off guard when asked whether they have a business plan. Some will say that their activity is very basic, that they know what they are doing, and that they don’t “need” a business plan.
What is a business plan? The business plan narrates what your business is all about, what kind of opportunity you see, and how you intend to make money. It is a guide for carrying forward your idea into a successful business operation. A business plan sets forth the overall market that you are targeting, and how your product or services compare with those of others. The length and breadth of the plan will depend on how much time you want to put into developing it.
The language of a business plan is usually simple and nontechnical. For many individuals, writing the plan is easy because of their prior experience in the field. For many, it is fun and creative.
The main focus of a business plan concerns your marketing strategy and financial projections. You should narrate your market strategy, and state why you believe this activity can be profitable. You could include as an appendix copies of market information you have researched.
You should also describe your competition and how you will be able to compete. You should set forth any competitive advantages that you have over other similar ventures.
In financial projections you want to show how much money you will need to spend to get the business going, what equipment, inventory, and materials you will need to obtain, and when you expect to make a profit. There should be an indication as to your reasonable estimate of revenue. This is usually very difficult to project. Just do your best, perhaps with the aid of others experienced in the industry. Your financial projections of profit should be reasonable, not exaggerated.
Preferably, your financial projections should cover a three- to five-year period. Some people hire an accountant or CPA to help prepare the projections, as this can further bolster the businesslike nature of the document, although you will still need to spend time developing the figures.
Most people project operating losses for the startup phase of the activity, which can be from three to seven years or longer, depending on the particular activity.
Prepare your business plan now; don’t wait to get audited. It is too late to muster up a plan once you are audited. The IRS wants to see business records that are maintained in the ordinary course of your activity, not those that you might prepare once you have been notified of an audit. Ideally, your business plan will be written before you start the venture, rather than midway through it.
If you are audited and you don’t have an existing business plan you should still prepare one, and admit that you have prepared it in connection with your audit. That is better than nothing. You can explain that the plan has always been in your head, and you thought it would be best at this time to reduce it to writing so that it can be clear how you forecast that this activity can be engaged in for profit. — John Alan Cohan, Attorney at Law