Dissolving unprofitable LLC

[spl]

Hello  -  I recently receive a notification from IRS to make the case whether my business is a hobby or a business.  In order to classify as a business , I am being asked to write a statement how I plan to make the business profitable going forward. Now, Is that normal for IRS to ask? if there is something more to come? Lastly, If I were to dissolve this business, would IRS make me pay all the tax write-off and charge a penalty? I really don't know and this is the reason why I am asking. Any help is appreciated.

thanks,

[Anonymous_]

If you believe there is actually no possible way to show some sort of profit in future years, then you might have resign yourself to the fact that the IRS will apply the hobby loss rules to the enterprise.

I recommend that you read the information at the link below, first.

https://turbotax.intuit.com/tax-tips/small-business-taxes/when-the-irs-classifies-your-business-as-a...

Subsequently, I recommend responding to the IRS notice with a statement that addresses each of the relevant factors (link below) in determining whether an activity is engaged in for profit.

https://www.ecfr.gov/cgi-bin/text-idx?SID=2c8c515e70d79f99314ab3dd0c63c6f4&mc=true&node=se26.4.1_118...

[Anonymous]

a business losing money year after year can expect either an audit or a letter/notice asking how the owner's plan to turn things around.  This might include showing that while losses year after year have been reported the underlying assets are appreciating  and if sold there would be a net profit for all the years combined.  The most common example of this would be real estate.  if the IRS does not accept your argument it's for profit, you can expect a bill maybe worse

this is something most taxpayers should not try to handle on their own.  Wisest thing would be to engage the services of a professional to look things over and give you an opinion.    Possibly even writing a letter providing info on how this will be profitable   or helping you settle with the IRS if they too deem it a hobby.  they would also discuss if you run other risks such as tax evasion.  

if you can't prove it's for profit,  you can expect the IRS to open all returns that can be opened either because the statute of limitations hasn't run or the losses produced a substantial understatement of tax liability.  generally this is no more than 6 years.  but if the IRS can show fraud  then 

[spl]

Thank you very much! 

[Carl]

I suspect that your busines has been open for at least 3 years, more likely longer. Generally, the IRS does not expect any new business to actually make a profit for at least the first 3 years. So if you continue to show a loss in year 4, that may get someone's attention at the IRS. If you still show a loss in year 5, that will definitely raise eyebrows and can result in a letter, just as has happened to you.

I this point I suggest you seek professional help for the main purpose of educating yourself so that you can make an "educated and informed" decision on weather to dissolve the LLC and continue as a hobby if you like, or figure out a way to actually make a taxable profit. There's two people I recommend you talk with.

First, someone experienced in the "business planning" field for whatever line of work your business does.

Second, a well educated tax professional. When it comes to "tax people" there are three very basic types. First, there's the EA (Enrolled Agent). An EA does not have to have any formal tax training like a CPA does. So I would not recommend you seek the services of an EA.

Next is a CPA (Certified Public Accountant). This person will be formally educated in accounting procedures, usually with an emphasis on business accounting. They are also educated on tax preparation for business taxes, and may or may not be educated on tax law.

Finally, there's the tax attorney. A tax attorney will have some type of credentialed degree in tax law.

While a tax attorney would be best for you, for your situation I would consider it to costly. Therefore I would go with a credentialed CPA. It should not be that difficult to find a CPA who is also experienced and well versed in the business planning field too. Then you can basically kill two birds with one stone.

[BMcCalpin]

It is true that you want to talk to a business person with experience in your industry who can advise you on whether you can reasonably ever show a profit, and how. The "and how" is important because the IRS will want to see a business plan that is both possible and doable as part of your demonstration that your business can reasonably be shown as "for profit".

I have a different take from Carl on "tax professionals", however. There are three types of tax professionals who can represent you in an audit by the IRS. By "represent" you, I mean that they can represent any taxpayer on any tax matter before any office of the IRS. Give this person a signed Power of Attorney, and you will not have to talk to the IRS again, because your tax professional will do all the communication.

Such tax professionals (ones who can represent you before the IRS) are governed by Circular 230 (https://www.irs.gov/pub/irs-pdf/pcir230.pdf). The Circular notes that attorneys, CPAs, and Enrolled Agents can all represent you on any tax matter (there are some other professionals who can represent you, but only on certain tax matters relating to their status).

Attorneys for your situation would generally be overkill. They will cost a lot (unless it's your brother-in-law who owes you a favor), and most attorneys never study tax anyway. The real benefit to a tax attorney is attorney-client privilege on criminal matters - if you think you were engaging in fraud or other criminal activity, then you want to talk only to a tax attorney. As was once said on "Law & Order", there is no accountant-client privilege for criminal matters.

During an audit, there is tax professional-client privilege, but only on matters related to the tax audit - any criminal matters mentioned by the taxpayer should cause the Enrolled Agent or CPA to immediately stop the interview to refer the taxpayer to an attorney.

A CPA may or may not know about tax. This is because accounting is a huge field, and tax accounting is only a small part of it. For example, at the University of Texas at Dallas, a large university that is part of the UT University system (and a mile from my house), the Professional Program in Accounting, a five year program that results in a B.S. and an M.S. in Accounting (and also allows you to sit for the CPA exam in your 5th year) has only ONE required course in taxation in those five years. (see https://jindal.utdallas.edu/accounting/ppa/curriculum/).

On the other hand, the IRS' Circular 230 describes Enrolled Agents like this: "The Commissioner, or delegate, will grant enrollment as an enrolled agent to an applicant eighteen years of age or older who demonstrates special competence in tax matters[emphasis mine] by written examination administered by, or administered under the oversight of, the Internal Revenue Service". (See Section § 10.4 on page 8).

Enrolled Agents must pass 12 hours of exams administered by the IRS (or licensed examiners) on individual tax, business tax (three types), and rules and procedures of the IRS. Carl is right that there is no requirement to take any formal tax training - but in reality, you can't pass those exams if you don't. Just doing tax returns for a couple of years is not enough to pass, much less walking in cold.

And note that Enrolled Agents are federally-licensed, whereas CPAs and attorneys are licensed by the state. Hence, for Enrolled Agents, the IRS and the US Tax Code are their main focus.

In short, you will find some CPAs who will be well-positioned to help you - but you are just as likely to find an Enrolled Agent who is well-positioned to represent you to the IRS. Personally, I found replying to IRS audit letters to be a fun part of the job. The IRS is inviting you to show them how they are wrong - and if you (or your tax professional) is convincing, you can change their minds.

Carl is correct that if you show a loss for 5 years running, the IRS will be genuinely puzzled as to how you ever expect to show a profit - but your reply, correctly formulated, may buy you another year - and by this point you had better have a plausible plan to show a profit 😉 or you need to "declare victory and go home"...

CPAs are easy to find - they probably have their own section in the Yellow Pages. But you can find local Enrolled Agents by going to the National Association of Enrolled Agents website at https://taxexperts.naea.org/.