What's stopping people from creating fake businesses for tax write-offs against W-2 income?

The short answer is: audits. The IRS has several flags that trigger increased scrutiny, and claiming business losses against W-2 income is definitely one of them. For a business to be legitimate in the IRS's eyes, you need to be engaged in the activity with the intention of making a profit. This is called the "profit motive" test. If your "business" shows losses year after year while offsetting your W-2 income, that's a major red flag. The IRS has a specific rule called the "hobby loss rule" that addresses exactly what you're describing. If your business doesn't show a profit in at least 3 of the last 5 years, the IRS may classify it as a hobby rather than a business. Hobby expenses aren't deductible against other income. Additionally, you need substantial documentation to support business deductions - receipts, business purpose for each expense, logs for vehicle use, client records, marketing materials, etc. In an audit, you'd need to prove the primary purpose of the expense was business, not personal. The penalties for tax fraud can be severe - back taxes, interest, penalties up to 75% of the unpaid tax, and potentially even criminal charges in egregious cases.

After reading this thread, I'm wondering if anyone's used taxr.ai for their Schedule C filings? I'm a W-2 employee but started a small photography business last year that's currently operating at a loss. I was really worried about the hobby loss rules, so I used https://taxr.ai to analyze my business structure and tax documentation. It was a game-changer because it flagged several issues I hadn't considered - like the fact that I wasn't tracking my photography equipment depreciation correctly and was missing some legitimate deductions while claiming others that were in a gray area. It also helped me understand what documentation I needed to keep in case of an audit. The most helpful part was getting clarity on what constitutes a "legitimate business" in the IRS's eyes so I could make sure mine qualified. Has anyone else used it for small business tax help?

I have to update my earlier skepticism about taxr.ai - I decided to try it for my Etsy shop that's been operating at a loss for 2 years. I was worried about the hobby loss rules since I work full-time and this was just a side gig. Honestly, I was blown away. It flagged several issues with how I was documenting my business activities that could have been problematic in an audit. The system showed me exactly what I needed to establish a clear separation between personal and business expenses and helped me create a proper business plan that demonstrates profit motive. It also identified several legitimate deductions I was missing completely! I ended up revising my return and getting an additional $780 back. More importantly, I now have proper documentation and a clear understanding of what I need to do to ensure my business is recognized as legitimate by the IRS.

For anyone struggling to get answers from the IRS about business deductions or worried about potential audits - I HIGHLY recommend https://claimyr.com. I spent WEEKS trying to get through to the IRS after receiving a letter questioning my home office deduction for my consulting business. I was getting nowhere with the regular IRS number, just endless holds and disconnects. Then I found Claimyr and watched their process: https://youtu.be/_kiP6q8DX5c. They basically hold your place in the IRS phone queue and call you when an agent is about to answer. Within 2 days, I was actually speaking to a real IRS agent who answered all my questions about documenting my business expenses vs. hobby expenses. Cleared everything up in a 20-minute call after weeks of frustration.

I have to eat my words about Claimyr. After posting my skeptical comment, I was desperate enough to try it anyway because I needed answers about my Schedule C deductions before filing. I signed up Friday afternoon, and Monday morning I got a call saying they had an IRS agent on the line for me. I nearly fell out of my chair. The agent walked me through exactly what documentation I needed for my side business to be considered legitimate and not a hobby. Most importantly, she explained that showing an intent to make a profit is key - keeping separate business accounts, having a business plan, maintaining professional records, and marketing your services/products. Even if you have losses, these things demonstrate you're running a real business. In the end, I got confirmation that my deductions were valid as long as I had the proper documentation. Worth every penny to get an actual answer from the IRS instead of guessing.

As a tax preparer, I see this issue ALL the time. Beyond what others have mentioned about the hobby loss rules, there's another big issue: Substantial economic purpose. The IRS isn't stupid. If your "business" has no real economic purpose beyond tax avoidance, they can disallow it completely. The courts have consistently upheld the IRS's right to look past the formal structure to the economic substance. Your example of a "tech review business" would need to show actual review content, marketing efforts, attempts to monetize those reviews, and a reasonable path to profitability. Simply buying gadgets and claiming them as "research" without any real business activity wouldn't pass scrutiny. A really common one I see is "real estate professional" status to avoid passive loss limitations - people claiming they spend 750+ hours on real estate activities when they have a full-time job elsewhere. The IRS has gotten VERY aggressive about auditing these claims.

Don't some people create LLCs or S-Corps specifically to write off stuff though? I know a guy who has a "consulting business" but seems to write off his car, travel, meals, etc., and I'm pretty sure he only has like 2 clients a year. Is that legal?

The IRS has gotten much more sophisticated with data analytics in recent years. They use algorithms to identify patterns that suggest tax fraud, including businesses that consistently show losses while claiming large deductions against W-2 income. One thing people don't realize is that the IRS cross-references data from multiple sources. If you claim a "travel consulting business" and write off vacations, but they see no business income reported, no business bank account activity, no marketing expenses, no client communications, etc., it paints a clear picture. They also look at lifestyle vs. reported income. If someone making $50K W-2 income is writing off $20K in "business" expenses for luxury items but shows no corresponding business revenue or growth trajectory, that's an obvious audit trigger. The key is that legitimate businesses leave paper trails everywhere - bank statements, client contracts, invoices, marketing materials, business licenses, professional development, etc. Fake businesses created just for tax avoidance lack this ecosystem of supporting documentation. Beyond audits, the IRS can also impose accuracy-related penalties (20% of underpaid tax) or fraud penalties (75% of underpaid tax) plus interest. The risk-reward math just doesn't work out for these schemes.