Congratulations on starting your own trading business! Owning and operating a small business, full- or part-time has been called the last great tax shelter. The Bottom Line: Business owners get tax benefits for countless expenditures not allowed for W-2 employees. Just about any expense that helps a business is tax-deductible as long as it is ordinary, necessary and reasonable. Some business expenses are fully deductible in the year they are paid, and other expenditures must be capitalized—that is, spread out and deducted over several future years. Not only can deductible expenses lower your taxable profit, they can provide a personal side benefit—a nice car to drive, a combination business trip/vacation and a retirement savings plan—if you follow the myriad of tax rules.
Let's jump right in and give you a list to review. Most will seem obvious, but some are commonly overlooked. The following are some of the more common business expenses that are deductible on Schedule C:
Amortization of improvement
Dues and publications
Education and seminars
Employment agency fees
Equipment rental and repair Freight
Interest on business debt
Office in-home expenses
Taxes - business
Taxes - city/county
Taxes - payroll
Taxes - personal
Taxes - personal property
Taxes - sales
Taxes - use
Commonly Overlooked Tax Deductions
Despite the fact that most people keep a sharp eye out for deductible expenses, it is not uncommon to miss a few. Here is a short list of routinely overlooked deductions:
· Advertising giveaways
· Coffee and beverage service
· Audio and video educational tapes
· Business association dues
· Consultant fees
· Business gifts
· Credit bureau fees
· Casual labor and tips
· Education for business skills
· Casualty and theft losses
· Online expenses
Business Use of the Home
Whether you are an employee or self-employed, you may be able to deduct certain expenses by using a part of your home for business purposes. To deduct business-use-of-the-home expenses, a part of your home must be used regularly and exclusively:
1. As the principal place of business for any trade or business in which you engage;
2. As the place where you meet and deal with your patients, clients, or customers in the normal course of your trade or business; or
3. In connection with your trade or business, if you use a separate structure that is not attached to your home.
If you use both your home and other locations regularly in the same trade or business, you must determine which location is your principal place of business. The two primary factors used to determine your principal place of business are the amount of time spent in each business location, and the relative importance of the activities performed at each location. After 1998, where you perform substantial administrative and management activities will also be considered in determining whether your home is your principal place of business.
In general, because of the exclusive use rule, you cannot deduct business expenses for any part of your home that you use for both personal and business purposes. For example, if you are an attorney and use the den of your home to write legal briefs and also for personal purposes, you may not deduct any business-use-of-your-home expenses. The only exceptions to the exclusive-business-use rule are for qualified daycare providers and for persons storing inventory or product samples used in their business.
If you are an employee, additional rules apply. Even if you meet the exclusive and regular use tests, you cannot take any deductions for the business use of your home unless this use of your home is for the convenience of your employer and your employer does not pay you rent for the portion of your home that you use in providing services as an employee.
Some of the deductible business use of the home expenses may include the business portion of real estate taxes, mortgage interest, casualty losses, rent, utilities, insurance, depreciation, painting and repairs. You may not deduct expenses for lawn care or for painting a room not used for business.
The amount you can deduct depends on the percentage of your home used for business. To figure this percentage, divide the number of square feet used for business by the total square feet in your home. Or, if the rooms are approximately the same size, divide the number of rooms used for business by the total number of rooms in your home. You figure the business portion of your expenses by applying this percentage to the total of each expense.
If your gross income from the business use of your home is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited. However, those business expenses that are not deducted because of the limit can be carried forward as part of next year's business-use-of-the-home expenses.
Business Use of Car
If you use your car in your job or business and you use it only for that purpose, you may deduct its entire cost of operation. However, if you use the car for both business and personal purposes, you may deduct only the cost of its business use.
The following rules apply only if you own the car you use in your job or business. You can generally figure your business use of car expense one of two ways: the standard mileage rate method or the actual expense method. For 1998, the standard mileage rate is 32.5 cents a mile for all business miles. If you use the standard mileage rate, add any parking fees and tolls incurred for business purposes. If you qualify to use both methods, figure the deduction both ways to see which gives you a larger deduction.
To use the standard mileage rate, you must own the car; the car must not be used for hire (for example, as a taxi), you must not operate two or more cars at the same time, as in a fleet operation, and you must not have claimed a deduction that included accelerated depreciation on the car in an earlier year.
Further, to use the standard mileage rate, you must choose to use it in the first year you place the car in service in your business. Then, in later years, you can choose to use the standard mileage rate or actual expenses. If you use the standard mileage rate in the first year, and change to the actual expense method in a later year, you must use straight-line depreciation over the estimated useful life of the car. You may not use an accelerated depreciation method.
To use the actual expense method of figuring the deduction for business use of a car, you must determine what it actually cost to operate the car. Include gas, oil, repairs, tires, insurance, licenses, garage rent, parking fees, tolls, and depreciation.
Business Travel Expenses
Travel expenses are the ordinary and necessary expenses that you pay while traveling away from home on business. You are traveling away from home if your duties require you to be away from your tax home for a period substantially longer than an ordinary day's work and you need to get sleep or rest to meet the demands of your work.
Generally, your tax home is the entire city or general area where your main place of business is located, regardless of where you maintain your family residence. For example, you live with your family in Chicago but work in Milwaukee where you stay in a hotel and eat in restaurants. You return to Chicago every weekend. You may not deduct any of your travel, meals, or lodging in Milwaukee because that is your tax home. Your travel on weekends to your family home in Chicago is not for business reasons, so these expenses are also not deductible. If you regularly work in two or more areas, your tax home is the general area where your main place of business or work is located.
You may not deduct expenses that are lavish or extravagant or that are for personal or vacation purposes. Also, you may not deduct travel expenses at a temporary work location if it is expected that you will work there for more than one year.
Some deductible travel expenses include:
1. Air, rail, and bus fares;
2. The cost of operating and maintaining your car;
3. Taxi fares or other costs of transportation between the airport or train station and your hotel, from one customer to another, or from one place of business to another;
4. Meals and lodging; and
5. Tips that are incidental to any of these expenses.
Meal expenses are deductible only if your trip is overnight or long enough that you need to stop for sleep or rest to properly perform your duties. The deduction for business meals is generally limited to 50% of the cost. Instead of keeping records of your meal expenses and deducting the actual cost, you can generally deduct a standard meal allowance ranging from $30 (for most areas in the United States) to $42 depending on where and when you travel.
You may also deduct travel expenses, including meals and lodging, you had from looking for a new job in your present trade or business. You may not deduct these expenses if you had them while looking for work in a new trade or business or while looking for work for the first time. If you are unemployed and there is a substantial break between the time of your past work and your looking for new work, you may not deduct these expenses, even if the new work is in the same trade or business as your previous work.
Travel expenses for conventions and seminars are deductible if you can show that your attendance benefits your trade or business.
Business Entertainment Expenses
Entertainment expenses directly related to or associated with your work may be deductible. You must have records to prove the business purpose and the amount of the expense, the date and place of the entertainment, and the business relationship of the persons entertained.
This deduction is generally limited to 50% of the expense. Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation. This includes entertaining guests at nightclubs, social events, theaters, sporting events, on yachts, or on hunting, fishing, vacation, and similar trips.
Deductible entertainment expenses must be ordinary and necessary. You must be able to show that they are directly related to, or associated with, the active conduct of your trade or business. For directly related entertainment, you must show that:
1. You had more than a general expectation of getting income or some other specific business benefit at some future time;
2. You did engage in business with the person being entertained during the entertainment period; and
3. The main purpose of the combined business and entertainment was the active conduct of your business.
The cost of food or beverages you provide a customer or client is deductible as entertainment (subject to the 50% limitation) only if you or your employee is present.
For associated entertainment, you must show that you had a clear business purpose for incurring the expense and that the entertainment directly preceded or followed a substantial business discussion.
None of the dues you pay for membership in any club organized for business, pleasure, recreation, or other social purpose are deductible.
Well-organized records will make it easier to prepare your tax return and will help you answer questions if your return is selected for examination, or you are billed for additional tax. Records such as receipts, canceled checks, and other documents that support an item of income or a deduction appearing on your return should be kept until the statute of limitations expires for that return. Usually this is 3 years from the date the return was due or filed, or 2 years from the date the tax was paid, whichever is later. There is no statute of limitations when a return is fraudulent or when no return is filed.
You should keep some records indefinitely, such as property records. You may need them to prove the amount of gain or loss if the property is sold. Generally, income tax returns should be kept for 3 years. They could help you prepare future tax returns or amend a return.
If you are in business, there is no particular method of bookkeeping you must use. However, you must use a method that clearly reflects your income and expenses, such as expenses for travel, entertainment, gifts, and cars. The records should substantiate your expenses.
Guest Writer & Tax Strategist
Optionetics.com – Your Options Education Site