Final answer:
The statement is true; profitability tests classify an activity as a trade or business for tax purposes. A profit in at least three of the previous five years, or two of seven years for horse-related activities, meets the presumption. Failing to make a profit can lead a business to cease operations.
Step-by-step explanation:
The statement that the Code provides a rebuttable presumption that an activity is profit-seeking if the activity shows a profit in at least three of the previous five tax years is true. If the activity involves horses, the presumption can be met if a profit is shown in two of the previous seven tax years. Meeting these profitability tests classifies the activity as a trade or business, rather than a hobby. These rules are designed to distinguish between activities done for profit and those that are not, in order to determine tax implications.
It is important for businesses to show profitability in order to justify their operations since the fundamental goal of a business is to make profits. Profits are calculated simply as Total Revenue - Total Cost. If a business consistently fails to make a profit, it may eventually cease to exist as its resources become depleted and its financial sustainability is compromised.