Thanks for mentioning this about being a dependent! So if my parents claim me, does that mean I'll end up owing more in taxes than if I filed independently? And what kind of things should I be tracking in this spreadsheet? Just dates, clients, and amounts or is there more I should be writing down?

Being claimed as a dependent could result in owing more taxes in some situations because your standard deduction might be lower than if you filed independently. However, there are other benefits your parents get from claiming you that might outweigh this difference for your family overall. For your spreadsheet, track way more than just the basics! Record dates, client names, payment amounts, payment methods, mileage to/from each client (with starting/ending odometer readings ideally), any supplies purchased (treats, bags, etc.), apps or software you use for the business, a portion of your phone bill if you use it for client communication, any insurance you get, and even home office expenses if you use part of your living space exclusively for business administration. Basically, document EVERYTHING with receipts. Tax time will be so much easier, and you'll maximize your deductions which directly reduces your taxable income.

This is a really good point. I'm in NYC and got completely blindsided by having to pay city tax on top of state and federal. It was an extra 3.8% I wasn't expecting!

But most small businesses like what OP is describing wouldn't hit anywhere near those $289k limits, right? Seems like you'd need to be losing a TON of money for those limits to matter.

You're right that most small sole proprietorships won't hit the Section 461(l) limits - I just wanted to point out that there are actually some caps on business losses that can be taken against other income. Many people don't realize there are any limits at all. The hobby loss rule is much more likely to affect typical small businesses though. If you show losses for 3+ years out of 5, the IRS might reclassify your business as a hobby, especially if you have substantial income from other sources. Then all those losses can't be deducted against your other income. This happens quite often with side businesses that consistently lose money.

Thanks for explaining! So basically once I've used the loss to reduce my personal income that year, it's "used up" and doesn't carry forward to future years of the business? That makes sense - I think I was confusing it with how corporations work. Would I get any different treatment if I formed an LLC instead of being a sole proprietor? Or would it work exactly the same way tax-wise?

That's really helpful info about the automatic penalty systems! Do you know if there's a specific form or procedure for "reopening" a partnership for tax purposes after a final return was filed? Or do I just file a regular 1065 again?

You just file a regular Form 1065 again. There's no special "reopening" form needed. Just make sure you don't check the "final return" box this time! The IRS systems are pretty forgiving about this situation since it happens fairly often. The most important thing is to make sure your client properly closes everything at the state level once they're truly done with the business. Until they formally dissolve the LLC with the state, they'll need to keep filing returns as long as there's any activity. Some states also require annual reports or minimum taxes just to maintain the LLC, even with zero activity.

In my experience, the penalties really depend on the amount of tax that was underpaid as a result. Small K-1 with minimal income? Probably just interest. Large K-1 with significant income? Could be 20% accuracy-related penalty plus interest. But filing voluntarily before they catch it is ALWAYS better than waiting.

This is exactly the kind of real-world experience I was hoping to learn from. Would you mind sharing what documentation the IRS specifically questioned during your audit? And did you qualify as a real estate professional or were you trying a different approach?

The documentation they zeroed in on was my activity log for proving real estate professional status. I claimed to meet the requirements but my records were inconsistent and some activities I counted weren't considered "material participation" by the auditor. I did qualify as a real estate professional based on hours, but they questioned whether I was truly spending more time on real estate than my primary job. They wanted to see detailed, contemporaneous records - not just a spreadsheet I created after the fact. They also scrutinized whether the rent I charged myself was truly market rate, asking for multiple comparable properties and professional rental assessments. One major issue was commingling of funds between personal and business accounts. They viewed this as evidence I wasn't treating the LLC as a separate entity. Make sure every expense goes through separate accounts and that you have a formal process for paying rent that looks like a true landlord-tenant relationship.

Good points. Also worth mentioning that mortgage rates for investment properties are typically higher than primary residences, often by 0.5-1%. So even if you find a lender willing to do this arrangement, you'll likely pay more for the mortgage, which could offset some of the tax savings.

That sounds stressful! Did you have to pay penalties for filing the wrong form? And did the IRS contact you about it, or did you discover the mistake yourself?

I discovered it myself after attending a tax workshop for international employees at my company. I filed an amended return (Form 1040-X) right away, which limited the penalties. I did have to pay some interest on the additional tax owed, but no major penalties since I corrected it voluntarily before the IRS caught it. The IRS did eventually send a notice, but by then I had already filed the amendment. The most painful part was that I had claimed some credits on the original Form 1040 that I wasn't eligible for as a nonresident, so I had to pay back that money plus interest. Don't make my mistake - get the form right the first time!

Sprintax is good but expensive! I found a free option through the IRS Free File program that handles 1040-NR, but you have to dig for it on their website.