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Small Business Tax Q&A: February ’17

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Is it a hobby or a business?

Q. My wife started a decorating business last year and showed a loss. Will this be treated as a hobby? C.M., Yakima, Wash.

A. Not necessarily. If your wife legitimately engaged in the activity with the intention of making a profit, the activity can be treated as a business—not a hobby—even if she showed a loss for 2016.

In this case, you can use the loss to offset your income from other sources. The IRS traditionally relies on nine factors to determine a profit intent, based on the facts and circumstances.

Note that there is a presumption that an activity is a for-profit business if you show a tax-return profit in three out of five years.

Tip: The IRS can rebut the presumption with evidence.

Tax pros and cons of child care

Q. We pay a baby sitter to watch our kids after school. Do we really owe payroll taxes on these payments? E.H., Demarest, N.J.

A. Technically, yes, if the amount you pay the baby sitter for the year exceeds the annual “nanny tax” threshold of $2,000, then you owe payroll taxes. This employment tax obligation applies to all domestic workers, even baby sitters who do nothing more than watch your young children.

On the plus side, if your children are under the age of 13, then you may qualify for a dependent care credit. The maximum credit is generally equal to $600 for one qualified child and $1,200 for two or more qualified children.

Tip: Proposed tax reforms could affect the dependent care credit.

Silver tax lining in business theft

Q. One of our workers stole money from our safe. Can we deduct this as a loss? D.M.B., Brooklyn, N.Y.

A. Yes. The amount the employee stole is eligible for a business deduction, assuming it can be substantiated. But you must subtract any amount of insurance reimbursements you receive from the deductible amount. Unlike personal losses, there are no other deduction limits for business theft losses. Personal theft losses are subject to a threshold of 10% of adjusted gross income after each loss is reduced by $100.

Tip: Make sure you keep copies of police reports and other supporting documentation.

1031 exchanges can’t cross borders

Q. Regarding your article on like-kind exchanges of real estate (SBTS, August 2016), can we exchange a property in Maryland tax free for one in Nicaragua? D.H., Virginia Beach, Va.

A. No. To qualify as “like-kind properties” under Section 1031 of the tax code, real estate located in the U.S. that you’re relinquishing must be exchanged for other U.S. property.

In addition, other requirements must be met, as spelled out in the article. For example, the replacement property must be identified or received within 45 days of transferring legal ownership; and you have 180 days or your tax return due date (plus extensions), whichever is earlier, to receive the title to the replacement property.

Tip: Property located in a foreign country can be exchanged tax free for other foreign property.

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