Small Business Audit Triggers Part 2

5. Losing money more than three out of five years. The IRS is on the lookout for people writing off hobbies as businesses. They want to see that you've at least had the intent to make a profit. Here are some of the factors that the IRS uses to determine whether an activity is caried on for profit or as a hobby

• Does the time and effort put into the activity indicate an intention to make a profit?
  


• Do you depend on income from the activity?
  


• If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
  


• Have you changed methods of operation to improve profitability?
  


• Do you have the knowledge needed to carry on the activity as a successful business?
  


• Have you made a profit in similar activities in the past?
  


• Does the activity make a profit in some years?
  


• Do you expect to make a profit in the future from the appreciation of assets used in the activity?

6. File a Schedule C return. If you're a sole proprietor, you'll file a Schedule "C" — Profit or Loss from a Business — as part of your 1040 form. BDO Seidman says the IRS is scrutinizing Schedule Cs more closely this year, so make sure you have proper documentation. But unless you're incorporated, you'll need to file this form. And according to an SBA report released just April 2, 2009, sole proprietors pay half the effective tax rate of S corporations (13.3 percent versus 26.9%).