October 9, 2014

Tax File Memorandum

From: Zachary Williams
Subject: Tax Memo 1
Facts:
Mr. Tardy, our newest client, having recently lost his job, has begun his
dream career of teaching employees better time-management skills. During 2013
and 2014, Mr. Tardy has incurred a net loss with his new career. Mr. Tardy is
convinced he can make his business a profitable one in the coming years. Mr. Tardy
wishes to declare his career a profit-seeking venture in order to deduct the full
amount of expenses. With this only being his second year of business, however, he
does not meet the 3 out of 5 year test (IRS Publication 535 (2013), p. 5).
Issue and Conclusion: Is there a way to give Mr. Tardy some protection and allow
him to deduct the losses in 2014 without worrying immediately about the IRS
disallowing his excess losses as a hobby?
1. Is there some way that Mr. Tardy can be presumed to be engaged in a forprofit activity until the three-for-five year rule is met?
2. If there is, what must be done to get this protection?
Yes.
Analysis: 1) Mr. Tardy can be presumed to be engaged in a for-profit activity until
the three-for-five year rule is met. According to IRS Publication 535, if an entity does
not 3 (or 2) years of profitable activity, the entity can elect to have this rule apply
only after the 5th (or 7th) year (P. 5, Not-for-Profit Activities). By doing this, the IRS
will not immediately question whether or not it is a profit-seeking activity or hobby.
Also, the IRS will not limit the deductions.
2) In order to get this protection, Mr. Tardy must file a Form 5213 with the IRS.
This form must be filed within 3 years of the due date of the return, for the year in
which the activity was carried on.
Final Conclusion: If Mr. Tardy believes he can make his career a profitable venture,
we can file a Form 5213 with the IRS. This form will allow Mr. Tardy to wait until year
5 (or 7) to determine whether or not the venture meets the three-for-five rule. This
form must be filed within 3 years of the activity in question, meaning it must be
filed by 2017, at the latest.