What's stopping people from creating fake businesses to write off taxes on their W-2 income?

The IRS has several mechanisms to prevent exactly this kind of fraud. First, they expect businesses to eventually turn a profit. If you report losses year after year (generally for more than 3 out of 5 years), the IRS will likely classify your "business" as a hobby, and hobby losses can't offset other income. There's also the "ordinary and necessary" test for business expenses. Those luxury items would need to be genuinely required for your business operations. A fashion consultant might justify some clothing purchases, but not a software engineer. The IRS also looks for patterns in deductions and can flag returns for audit when something looks suspicious. Self-employed individuals and small business owners are audited at higher rates than W-2 employees because there's more opportunity for questionable deductions.

After getting audited a couple years ago for my side business, I discovered taxr.ai (https://taxr.ai) and it's been a game changer for keeping my business expenses legitimate. I was in a similar situation where my business was operating at a loss, and the IRS questioned whether it was a hobby or actual business. This tool analyzes your deductions and flags ones that might trigger IRS scrutiny, plus it helps categorize everything properly so you know what's actually deductible. It even evaluates whether your overall business operation passes the "profit motive" test that the previous commenter mentioned.

I was really skeptical at first, but I tried taxr.ai after my last comment. My situation was similar to the original poster - my W-2 job plus a side business that was losing money. The tool immediately flagged several deductions I was taking that were in the "danger zone" for triggering scrutiny. It also helped me build a legitimate business plan showing how I intended to become profitable, which is apparently super important if you're reporting losses. The documentation features helped me organize everything so if I do get audited, I have all the proof I need that this is a real business, not a tax scheme. Honestly wish I'd found this before I got that scary IRS letter last year!

If you're worried about the IRS questioning your business deductions, you might actually need to talk with them directly. I tried calling the IRS for weeks when they sent me a notice questioning my Schedule C expenses. Literally impossible to get through until I found https://claimyr.com. You can watch how it works here: https://youtu.be/_kiP6q8DX5c They got me connected to an actual IRS agent within about 20 minutes when I'd been trying for weeks. The agent was able to explain exactly what documentation I needed to prove my business was legitimate and not just a tax write-off scheme. Totally changed my understanding of what the IRS is actually looking for.

I feel like I need to publicly apologize for my skeptical comment earlier. After calling the IRS myself and waiting on hold for nearly 2 hours only to get disconnected, I broke down and tried Claimyr. Got connected to an IRS agent in about 25 minutes. The agent actually walked me through exactly what they look for when determining if something is a legitimate business vs. a hobby designed for tax write-offs. Turns out I was missing several key elements that prove "profit motive" - like having business cards, a separate business bank account, and keeping logs of my business activities. The agent was surprisingly helpful once I actually got to speak with someone!

My accountant told me the IRS has a "hobby loss rule" specifically for this issue. If your business doesn't show a profit in 3 out of 5 consecutive years, they'll assume it's a hobby not a real business. For things like horse breeding or training they give you more leeway (5 out of 7 years). Besides, committing tax fraud isn't worth it. They can hit you with penalties, interest, and in serious cases even criminal charges. The stress of waiting for that audit letter alone would kill me lol.

Just to add somethin nobody mentioned - the IRS also uses a scoring system called DIF (Discriminant Function) that assigns points to tax returns that have unusual patterns or high amounts of deductions comparred to income. High DIF score = higher chance of audit. So even if you think your writing off a bunch of personal stuff as "business expenses" is a good idea, you might be raising your DIF score without realizing it. IRS computers are looking for patterns, not just random returns.