Wukong once whispered in the wind:
"Wouldn't think of doing the DE corp game when you are not a US citizen and then use corp to "own" the vessel. Also, the IRS would look upon your corp as a fraud as well, since legally, a corp has to be a for-profit operation."
You are right about the non-citizen thing.
However, you would not have any problem with the IRS or fraud. A corporation does not have to be "for profit." It only has to be engaged in a legal activity. Ownership of property is a legal activity for a corporation. For tax (US) purposes a "S" corporation pays no federal taxes, any income is passed directly to the shareholders. Anyone in the US that is paying any state more than about $300 in sales tax and perhaps personal property taxes annually on a boat need to discuss a DE Corp with their tax advisor. Managing your affairs to minimize taxes is not evasion.(Judge Learned Hand)
Sorry, but that is not correct. In order to be able to run the business and deduct your expenses, you need to have the following proof. Here is a quote from the website smbiz.com. It's copyrighted, so I want to note that. My connection isn't behaving well enough to find all the IRS pubs for you. Bascially, if you look up "hobby losses" and "dertermination of for-profit" status you will see what I'm saying comes right down from the IRS.
spell out nine factors that should be examined in determining if an activity is engaged in for profit. These are the factors the IRS and the courts look at. All facts and circumstances with respect to the activity are to be taken into account. No one factor is determinative in making this determination. In addition, it is not intended that only the factors described below are to be taken into account in making the determination, or that a determination is to be made on the basis that the number of factors indicating a lack of profit objective exceeds the number of factors indicating a profit objective, or vice versa. In other words, the IRS and courts can cherry pick and weigh factors. For example, assume the court looks at 9 factors. Six of those are in your favor; three for the IRS. The court determines that one of the factors in the IRS's favor should carry much more weight. The court could rule
for the IRS. Among the factors which are normally taken into account are:
1. Manner in which the taxpayer carries on the activity. The fact that the taxpayer carries on a activity in a businesslike manner and maintains complete and accurate books
and records may indicate that the activity is engaged in for profit. Similarly, where an activity is carried on in a manner substantially similar to other activities of the same nature which are profitable, a profit motive may be indicated. A change of operating methods, adoption of new techniques or abandonment of unprofitable methods in a manner consistent with an intent to improve profitability may also indicate a profit motive.
Most taxpayers fail to keep accurate books
and records. Without these you can't know how the business is doing and you can't improve profitability. Based on the cases, good recordkeeping will go a long way in impressing the court. That's one of the most often cited issues the courts consider. Modifying your business plan to improve profitability is also critically important.
2. The expertise of the taxpayer or his advisors. Preparation for the activity by extensive study of its accepted business, economic, and scientific practices, or consultation with those who are expert therein, may indicate that the taxpayer has a profit motive where the taxpayer carries on the activity in accordance with such practices. Where a taxpayer has such preparation or procures such expert advice, but does not carry on the activity in accordance with such practices, a lack of intent to derive profit may be indicated unless it appears that the taxpayer is attempting to develop new or superior techniques which may result in profits from the activity.
The courts often look first at the expertise of the taxpayer. For example, someone who has spent considerable time in various retailing operations has a better chance of succeeding at selling on the web. That's the best situation. If you have little or no expertise in the field but consult experts such as a CPA, marketing
, etc. your position is improved. The further afield the activity from your base knowledge, the more you should consult experts.
3. The time and effort expended by the taxpayer in carrying on the activity. The fact that the taxpayer devotes much of his personal time and effort to carrying on an activity, particularly if the activity does not have substantial personal or recreational aspects, may indicate an intention to derive a profit. A taxpayer's withdrawal from another occupation to devote most of his energies to the activity may also be evidence that the activity is engaged in for profit. The fact that the taxpayer devotes a limited amount of time to an activity does not necessarily indicate a lack of profit motive where the taxpayer employs competent and qualified persons to carry on the activity.
A casual interest in the activity, or an interest because of a related motive (farming because you want to get away from the city, horse breeding because your daughter wants to ride), doesn't bode well. Keeping a log of the amount of time spent on the activity and the work performed may be helpful.
4. Expectation that assets used in activity may appreciate in value. The term "profit" encompasses appreciation in the value of assets, such as land, used in the activity. Thus, the taxpayer may intend to derive a profit from the operation of the activity, and may also intend that, even if no profit from current
operations is derived, an overall profit will result when appreciation in the value of land used in the activity is realized since income from the activity together with the appreciation of land will exceed expenses of operation.
For example, you purchase
a tract of land in the suburbs and run a small amusement park. While the amusement park is unlikely to be a consistent moneymaker, the land is appreciating rapidly, allowing an overall profit from the activity. Caution. Special rules apply when you operate a farm.
5. The success of the taxpayer in carrying on other similar or dissimilar activities. The fact that the taxpayer has engaged in similar activities in the past and converted them from unprofitable to profitable enterprises may indicate that he is engaged in the present activity for profit, even though the activity is presently unprofitable.
6. The taxpayer's history
of income or losses with respect to the activity. A series of losses during the initial or start-up stage of an activity may not necessarily be an indication that the activity is not engaged in for profit. However, where losses continue to be sustained beyond the period which customarily is necessary to bring the operation to profitable status such continued losses, if not explainable, as due to customary business risks or reverses, may be indicative that the activity is not being engaged in for profit. If losses are sustained because of unforeseen circumstances which are beyond the control of the taxpayer, such as drought, disease, fire, theft, weather
damages, other involuntary conversions, or depressed market conditions, such losses would not be an indication that the activity is not engaged in for profit. A series of years in which net income was realized would of course be strong evidence that the activity is engaged in for profit.
7. The amount of occasional profits, if any, which are earned. The amount of profits in relation to the amount of losses incurred, and in relation to the amount of the taxpayer's investment and the value of the assets used in the activity, may provide useful criteria in determining the taxpayer's intent. An occasional small profit from an activity generating large losses, or from an activity in which the taxpayer has made a large investment, would not generally be determinative that the activity is engaged in for profit. However, substantial profit, though only occasional, would generally be indicative that an activity is engaged in for profit, where the investment or losses are comparatively small. Moreover, an opportunity to earn a substantial ultimate profit in a highly speculative venture is ordinarily sufficient to indicate that the activity is engaged in for profit even though losses or only occasional small profits are actually generated.
8. The financial status of the taxpayer. The fact that the taxpayer does not have substantial income or capital from sources other than the activity may indicate that an activity is engaged in for profit. Substantial income from sources other than the activity (particularly if the losses from the activity generate substantial tax benefits) may indicate that the activity is not engaged in for profit especially if there are personal or recreational elements involved.
9. Elements of personal pleasure or recreation. The presence of personal motives in carrying on of an activity may indicate that the activity is not engaged in for profit, especially where there are recreational or personal elements involved. On the other hand, a profit motivation may be indicated where an activity lacks any appeal other than profit. It is not, however, necessary that an activity be engaged in with the exclusive intention of deriving a profit or with the intention of maximizing profits. For example, the availability of other investments which would yield a higher return, or which would be more likely to be profitable, is not evidence that an activity is not engaged in for profit. An activity will not be treated as not engaged in for profit merely because the taxpayer has purposes or motivations other than solely to make a profit. Also, the fact that the taxpayer derives personal pleasure from engaging in the activity is not sufficient to cause the activity to be classified as not engaged in for profit if the activity is in fact engaged in for profit as evidenced by other factors.
While enjoying the activity is rarely a critical factor by itself, it's often a tip-off. For example, listing auto racing
, yacht chartering, modeling, antique dealer, etc. as the business on a Schedule C could generate questions by itself.
While most taxpayers assume the hobby loss rules (the actual name of the code section is "Activities Not Engaged in for Profit") only apply to sole proprietorships, that's not true. They apply to any business--S corporations, LLCs, partnerships, etc. Only regular (C) corporations are truly immune. The rules can also apply to rental properties, such as the rental of a second home.
The rules also apply by activity. That means you can't combine two activities to have the losses from one offset the profits of another. For example, you've got an S corporation that rents heavy construction equipment
and turns a regular profit. You put your 60-foot sailboat that you charter
out with consistent losses in the S corporation. While the S corporation may generate a profit, the IRS can still claim the yacht charter
is not engaged in for profit and disallow those losses. On the other hand, if the S corporation's primary or first business was as a marina, shipyard, or similar venture, it's more than likely the IRS would consider the yacht chartering to be combined with the other activity.
The rules are intended to disallow deductions for expenses. But they can also be important if you sell an asset for a loss you claim was used in a business. Losses on the sale
of business property (e.g., vehicles, equipment) can generate a full deduction. Losses on nonbusiness assets may be deductible as a capital loss or may not be deductible at all.
Even if the IRS or courts rule
that your activity is not for profit, that doesn't mean you lose all the deductions. The deductions are disallowed according to a 3-step approach. Expenses that would be deductible regardless of a business activity (taxes, interest) are deducted first. Next, expenses that would be deductible if the activity was engaged in for profit, but only if the deduction does not result in an adjustment to basis (e.g., depreciation, worthless debts, amortization) and only up to the gross income from the activity. Finally, amounts resulting in an adjustment to basis, but only up to the remaining income from the activity.
Example 1--Assume you have gross income of $5,000 from your dog breeding venture. Your expenses are $800 for taxes, and $4,700 for stud fees
, vet bills, etc. and $500 for depreciation of equipment
. Your deductions would be limited to $5,000--$800 for the taxes and $4,200 for the stud fees
, leaving you with a net profit of zero.
Example 2--Assume the facts are the same as above, but the stud fees, food
, etc. total only $3,900. Your deductions would be limited to $5,000--$800 for taxes, $3,900 for fees, food, etc. and $300 for depreciation.
If there is personal use involved, you'll have to allocate the expenses. For example, if you charter your sailboat for 9 months of the year and use it for personal purposes for 3 months, you can only use 3/4 of the maintenance
expenses, slip fees, etc.
Even if you're never challenged on the profit motive of your venture, you still have to pass the passive activity and basis tests. That is, in order to claim the losses you have to materially participate in the activity and have sufficient basis to take the losses.
What are your chances if challenged by the IRS? Based on the court cases (there have been hundreds of them over the years), the IRS is victorious in the vast majority. But a closer examination shows most taxpayers lose because they're not taking even the most basic steps to improve their position. There's nothing you can do to make auto racing
not have an element of pleasure, but you can:
* Keep good records
* Analyze your operations regularly (at a minimum, semiannually; quarterly or monthly if warranted)
* Get advice from experts
* Change operations to improve profitability
* Spend as much time as possible on the activity
* Keep a log or diary of time spent, work performed, etc.
* Document problems beyond your control, e.g., sales were down in 2005 because of a fire in the adjacent store
So in conclusion, you can own a company that owns a boat, but if you aren't running it for profit, you can't deduct any of your expenses, resulting in no gain.