|
Tax Benefits for the Self Employed and Home Based Business Owner
The small business owner is the engine that runs our economy and home based businesses are a huge component. Many of the largest corporations in the world were started as home based businesses!
Ever hear of a little company called Apple? Steve Jobs started that company in his garage! Michael Dell started his little venture as a home based business as well, building computers from component parts out of his apartment at the University of Texas and selling them out of his car.
Congress acknowledges the importance of the American entrepreneurial spirit and that in order to do so people put their hard earned capital at risk to pursue their dream and has rewarded us with LEGAL TAX DEDUCTIONS to help keep our economic engine humming.
The question most new business owners ask is “What can I deduct?” That is a simple question with a not so simple answer. Logically, however, a very general rule is, “If it has to do with maintaining or promoting your business, it is deductible.”
Here are four examples of things you can legitimately deduct if you are self employed. This is not an exhaustive list, but simply a primer to whet your appetite to learn more and take full advantage of the MONEY IT WILL PUT BACK IN YOUR POCKET, effectively giving yourself a raise!
Business Use of Your Home
You may be one of those people who say “I would never have a home based business, because it will trigger an audit.” How foolish and uninformed! An audit is no fun, but if you are doing things ‘by the book’ and documenting them properly, the money you save will pay for the short term anxiety MANY TIMES OVER. And besides, the chance you will be audited range from .5% if you are set up as an S Corp to 3% if you are a Schedule C ‘filer’.
In an attempt to set your mind at ease regarding a home based business, look at Form 8829.
This is the IRS document for “Expenses for Business Use of Your Home”. If the business use of your home was not legitimate, why would the IRS provide this form so you can calculate the expense for tax purposes? The use of your home for business is legitimate!
Notice what it says in Part 1.1.
1 Area used regularly and exclusively for business, regularly for daycare, or for storage of Inventory or product samples
You can deduct the percentage of your mortgage, insurance, utilities, etc. that correlates to the area of your home you are using “REGULARLY AND EXCLUSIVELY” for your business (unless it is a daycare).
Is your home your ‘Principal Place of Business’? It is very easy to determine. Here is what the IRS says about that in their instructions for Form 8829.
In determining whether the office in your home qualifies as your principal place of business, you must consider the following two items.
· The relative importance of the activities performed at each place where you conduct business, and
· The amount of time spent at each place where you conduct business.
Your home office will qualify as your principal place of business if you meet the following requirements.
· You use it exclusively and regularly for administrative or management activities of your trade or business.
· You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.
Administrative or management activities. There are many activities that are administrative or managerial in nature. The following are a few examples.
· Billing customers, clients, or patients.
· Keeping books and records.
· Ordering supplies.
· Setting up appointments.
· Forwarding orders or writing reports.
If you have inventory you can also deduct the area of your home used for that. Here is what the IRS says;
You can also deduct expenses that apply to space within your home used on a regular basis to store inventory or product samples from your trade or business of selling products at retail or wholesale. Your home must be the only fixed location of your trade or business.
In conclusion, if your home qualifies as your principal place of business you can deduct the percentage of your home that is used “exclusively and regularly” for your business AND you have “no other fixed location where you conduct substantial administrative or management activities.
Many of us do not have the resources to rent office space when we are starting our businesses. We have a dream, the desire and determination to make it work and little else. Congress, realizing that, has provided that we can deduct our home office expenses to help us become the next billion dollar company, just like Steve Jobs and Michael Dell.
Mileage
You can deduct the expenses you incur on your vehicle OR take the standard mileage deduction for four or less vehicles (if you have five or more vehicles you cannot use the mileage deduction).
 In 2009 this deduction allowed 55 cents a mile to be deducted from income for each mile driven for business purposes. Publication 463, pages 15 & 16 discuss this in detail. The caveat is you may deduct mileage OR you may expense your vehicle, but you cannot do both. One thing people hate doing is to ‘track’ their mileage. Congress, in a rare benevolent mood, has provided a solution. You may use ‘Sampling’ in order to gather the percentage of the time/miles you are using your vehicle(s) for business.
In this example the IRS states you may sample your use by keeping ‘an adequate record for parts of a tax year…’
In their example records are kept for the first week of each month and show that 75% of the cars mileage is used for business. You are entitled to then expense 75% of the mileage on your vehicle for the year.
The trick is to keep “ADEQUATE” records. This will require some effort on your part, but that effort will be handsomely repaid at the rate of 55 cents a mile.
Using the 75% example above, if you travel 1000 miles a month, you are allowed a deduction of $412.50 a month. For a year that comes out to $4950. That is a very healthy deduction and in many cases will pay for the cost of maintaining your business.
Travel
Th e IRS says a lot about business travel and provides specific examples to clarify their intent.
Take, for instance, luxury water travel. LUXURY WATER TRAVEL! YOU CAN DEDUCT LUXURY WATER TRAVEL? According to the IRS, in specific circumstances you can, yes.
In the example to the left you see an excerpt from pages 8 & 9 of Publication 463. Caroline, a travel agent, can deduct up to $4,025 based on their estimates because she is on business. That is not to say that anyone can deduct ‘cruise’ travel, because that is not the case.
If you read further on page 9 it talks about doing business on ‘cruise ships’. After pointing out that up to $2000 a year can be deducted on conventions, seminars, etc. held on cruise ships, it qualifies that with five bullet points, two of which are related to the ship registry and ports of call.
For a cruise to be considered for business purposes it must be a US registered ship and stop only in US ports. How many ships and cruises meet that criterion? VERY FEW cruises qualify and if you are interested in finding one that does for a corporate event please call us for more information (number provided at the bottom of this page).
There are other requirements for business travel, conventions, etc. that you may read about as well. Download a pdf of Publication 463 and read pages 2 through 9. They deal specifically with business travel and the legal deductions afforded you as a business owner.
Entertainment
There is a great deal of misunderstanding when it comes to the issue of what ‘entertainment’ can be deducted as a business expense. Entertainment is defined by the IRS as including “any activity generally considered to provide entertainment, amusement, or recreation, and includes meals provided to a customer or client”, page 10, Publication 463. Can you think of anything that falls in those categories?
The basic qualifiers for entertainment to be deductible (generally at 50%) are that it is both an ordinary and necessary expense to your business, and does it meet the 1) directly-related and 2) associated tests.
An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your business.
The Directly-Related Test is
1. The main purpose of the combined business and entertainment was the active conduct of business.
2. You did engage in business with the person during the entertainment period.
3. You had more than a general expectation of getting income or some other specific business benefit at some future time.
Example – You invite someone to join you for lunch so that you can talk to them about the direct marketing business you are building followed by a round of golf in the hopes of getting them to join your team. Your business meeting/lunch and the golf are deductible at 50%. Be sure that your documentation indicates specifically the business discussed and that it was ‘preceded’ or ‘followed’ by golf.
You cannot simply take someone to lunch or to play golf and deduct that as a business expense!
Remember, the key to the entertainment expense is that the ‘primary purpose’ of the expense MUST be business. For the entertainment to be considered ‘business’ your primary purpose of the meeting MUST be to have a “discussion, meeting, negotiation, or other business transaction to get income or some other specific business benefit” (page 10, Publication 463).
If the meeting and entertainment do not strictly meet the “Directly-Related Test” they may meet the Associated Test. For entertainment to qualify under this test you must be able to show the entertainment is
1. Associated with the active conduct of your trade or business, and
2. Directly before or after a substantial business discussion.
These are just four examples of the types of legal deductions you can avail yourself of if you are self employed. Remember, Congress set these up to assist people like yourself, the entrepreneur. It is they who are willing to take the risk to step out and risk their time and capital to build a business which will benefit everyone through employment, purchases and yes, even paying taxes on profit.
For more information on how to purchase our CD series on Tax Strategies for the Self Employed, send an email to admin@xpensetrax.com and we will contact you. Please provide a convenient time to call.
|
