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#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!