The key is understanding what’s deductible for your business.
Opportunities abound for small businesses (home based business) to cut their tax bills.
Organization and good record keeping are the keys to lower tax preparation fees and painless IRS audits. (Remember the IRS love to audit home based businesses) So bringing a shoe box to your CPA or accountant and saying, Here are my tax records; please prepare my return’ will undoubtedly cost you more in compilation and accounting fees to arrive at tax return numbers.”
Here’s a rundown of expenses to track in preparation for tax day.
1. Expenses to Start up or Expand your business: The biggest mistake in deducting expenses to start-up or expand your business is failing to make an election to amortize or deduct these expenses in the first year. A paper election is required to be attached to the return, stating your intention to amortize them. Otherwise, the expenses become nondeductible until you sell or liquidate the business.
2. Home office: The home office deduction is one of the more complex deductions. In short, any workspace that you use regularly and exclusively for your business, regardless of whether you rent or own, can be deducted as a home office cost. While you are basically on the honor system, you should be prepared to defend your deduction in the event of an audit. Make sure to prepare a specific map of your workspace, with the correct measurements, in case you are required to submit this information to receive your deduction. And don’t forget to include your restroom, as the government expects your home company to need facilities too. To qualify, the room must be used exclusively for business. It can’t double as a spare bedroom or toy room for your kids. You can deduct a portion of rent(if you are renting),or mortgage if you own, utilities, insurance, homeowners insurance, taxes, maintenance, professional cleaning, depreciation and interest. State tax deductions will vary. For example, if your home office occupies 15% of your home, then 15% of your annual electricity bill becomes tax deductible. (Check with your state)
3. Telephone and Internet: Regardless of whether you claim the home office deduction, you can deduct your business phone, FAX and Internet expenses. The key here is to only deduct the expenses that are directly related to your business. If you have only one phone, you shouldn’t deduct its basic monthly charge, which you would likely incur whether you worked from home or not. You should only deduct costs that specifically relate to your business. If you have a second phone line that you use exclusively for business, however, you can deduct 100% of that cost. By the same token, you would only deduct your monthly Internet expenses in proportion to how much of your time on-line is related to business – perhaps 25%.
4. Equipment, furniture and supplies: Look at your purchases and ask your tax preparer to run the calculations to see if you should expense it or depreciate it. But don’t overdo it, often the entrepreneur buys a piece of equipment just to get a tax deduction which often isn’t good business sense.
5. Professional publications and software: The cost of specialized magazines and books directly related to your business is tax deductible. For example, a daily newspaper would not be specific enough to be considered a business expense, but a subscription to the CPA Journal would be tax-deductible if you are a Certified Public Accountant (CPA). (And yes, some people are passionate about accounting.) Here again, the common error is taking the cost as an expense instead of amortizing. Software licensing fees, for example, should be capitalized and amortized over 60 months unless it has a life of only one year, such as an annual maintenance agreement. Professional publications should be amortized over the subscription period if prepaid.
6. Education and Training: You may deduct the cost of continuing education or certification for the business you’re already in, but education that qualifies you for a new line of business is not deductible.
7. Gifts and Advertising: Client gifts are deductible up to only $25 per gift. And if you advertise, deductions taken for costs that cover multiple-year contracts must be spread over all the contract years.
Gifts not confused with Charity ~
8. Charity: Save all your receipts, and don’t forget to keep track of contributions of inventory or property.
9. Interest on loans: You can fully deduct interest on loans for your business. If you have a loan from a relative, make sure it conforms to IRS rules.
10. Entertainment and travel expenses: Keep excellent records here, and keep a log of who you met, why, where, when and for what business purpose. “Only 50 percent of meals and entertainment costs is deductible, and none of the costs associated with country club memberships are deductible.
100% of your travel expenses for business are deductible, except for meals and entertainment, which are limited to 50%. If your trip does not involve an overnight stay, you can still deduct the cost of transportation, but you cannot deduct the cost of meals as a travel expense. If your trip combines business with pleasure, however, things get a lot more complicated.
Taxpayers should be particularly careful to maintain complete and accurate records and receipts for their business travel expenses and the business activities they performed, as this deduction often draws attention from the IRS. Deductible travel expenses include the cost of transportation to and from your destination (such as plane fare), the cost of transportation at your destination (such as a car rental or subway tickets), lodging and meals. You are even allowed to travel luxuriously, taking first class flights or staying at four-star hotels, but remember, it’s you, not the IRS, who will be paying the bulk of your travel costs.
IRS is very sticky on Travel and Entertainment . Keep complete records and notes.
11. Taxes and Social Security: State taxes paid are a healthy deduction; just don’t allow yourself to be surprised by how high Uncle Sam’s bill may be. I often advise setting aside 50 percent of net income to cover everything. If there is something left over, the refund is that much sweeter.
The Best Self-Employed Tax Deduction of All: Self-Employed Retirement Plans: Self-employed retirement plans – such as SEP-IRAs, SIMPLE IRAs, Keogh plans and solo 401(k)s – are particularly valuable for reducing your tax bill now and racking up tax-deferred retirement savings for later. Contribute as much as 25% of your net earnings from self-employment (not including contributions for yourself), up to $51,000 for 2013 ($52,000 for 2014).
Make salary deferrals up to $17,500 in 2013 and 2014 (plus an additional $5,500 if you’re 50 or older) of your compensation from the business either on a pre-tax basis or as a designated Roth contribution.
Contribute up to an additional 25% of your net earnings from self-employment (not including contributions for yourself), up to $51,000 for 2013 ($52,000 for 2014) including salary deferrals.
Tailor your plan to allow access to your account balance through loans and hardship distributions
Those who don’t make quite as much can contribute to both a self-employed retirement plan and an IRA (as long as you are within the IRA’s income phase-out limits). And, if you still have a day job where your employer doesn’t offer any kind of retirement plan, starting your own profitable business will get you out of the only-$5,000-a-year rut (the maximum annual IRA contribution) and allow you to start saving more for retirement.
Note: A one-participant 401(k) plan is sometimes referred to as a “solo-401(k),” “individual 401(k)” or “uni-401(k).” It is generally the same as other 401(k) plans, but because there are no employees other than your spouse who work for the business, it is exempt from discrimination testing.
Remember things are different from state to state.