Question

If the IRS determines that a business is not carried for profit, what choice does a taxpayer have in deducting any expenses incurred in association with the business?

Answer 1

If your activity is not carried on for profit, losses from that activity may not be used to offset other income. There are certain deductions which must be taken in the following order and only to the extent stated in each of three categories:

1. Deductions that a taxpayer may take for personal as well as business activities may be taken in full such as such as those for home mortgage interest, taxes, and casualty losses, belong in this category.
2. Deductions that don’t result in an adjustment to basis are taken next, to the extent gross income for the activity is more than the deductions from the first category. Deductions such as advertising, insurance premiums and wages, belong in this category.
3. Business deductions that reduce the basis of property are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories. Deductions such as depreciation and amortization are covered here.

For further info. https://www.irs.gov/pub/irs-pdf/p535.pdf, business expenses