Tax Tips for Home & Small Business Owners

The size of a small or home business tax bill can be a reflection of the business owner’s skills and knowledge in tax law and allowable tax deductions. Business owners need to be sure that they are meeting their tax obligations - but they should also seize every opportunity to reduce their taxes. The tax tips below will ensure the tax man is not getting more than his fair share.

Tax Basics

Your gross business income is the amount of money your business takes in without subtracting your expenses. Knowing what you can deduct under state and federal law can make a huge difference in your actual income. Knowing what you can’t deduct can save you not just embarrassment but also the unwelcome attentions of the IRS for a long time to come.

The IRS uses two common standards to determine whether a deduction is legitimate for your business:

  • Is it ordinary? An ordinary expense is defined as one that is generally common and accepted in your type of business.
  • Is it necessary? A necessary expense is one that is helpful and appropriate for the business that you are engaged in.

So far, these standards as defined sound very ambiguous. Helpfully, the IRS has refined business deductions so that very little guesswork is involved in determining if an item or an activity is deductible from your gross business income. Here is a list of expenses that are commonly deductible business expenses:

Travel, Meals and Entertainment

Expenses for travel, meals, and entertainment must be considered ordinary and necessary in your line of business. The IRS tends to look closely at entertainment expenses these days, so the “ordinary and necessary” link must be clear. Travel expenses are deductible if you are required to be away from home more than a day because of business – and you must sleep on the road. If these two conditions are met, you can deduct your transportation costs, car maintenance (if you drive your own car), rental cars, meals, tolls, parking, and lodging.

Home Office

The home office continues to be an issue between business owners and the IRS. In order to deduct your home office, you must show that you use your home office regularly and exclusively for conducting your business. Furthermore, it must be your principal place of business, where you meet clients or customers routinely. If you have set up a corner in your family room where the children watch TV every day, you cannot deduct that space, or that room, as your home office.

For more information on home office deductions read Calculating Home Offic & Depreciation.

Vehicles

Business owners can deduct car expenses for trips to see clients or to participate in business-related activities. The standard mileage rate allowed by the IRS is 48.5 cents per mile. You may elect to use the standard mileage rate or your actual expenses for your vehicle, including gas, oil changes, repairs, insurance, and registration. If you go with the standard mileage rate, you can change over to actual expenses another year. However, you can’t go from actual expenses to standard mileage at a later time. Generally, if you drive a lot for your business, the standard mileage rate is the preferable election unless you drive a car that requires a very large amount of gas. The use of actual expenses require complete record keeping to satisfy the IRS in case of audit.

Pension Plans

You can deduct contributions you make in a pension plan or savings match plan that you have established. IRS Publication #560 is a useful booklet on retirement plans for small businesses. IRS Publication #590 is concerned with Individual Retirement Arrangements (IRAs). Both of these are free and contain valuable information for those starting up a new business.

Depreciation

Depreciation for tax purposes means spreading the cost of a major purchase over the expected life of the object. The object, or business asset, must be used in the business, expected to last more than one year, and expected to lose its value over a period of years. Assets that cannot be included for depreciation are land, inventory, and repairs and maintenance that don’t increase the life of the asset (the latter are usually deducted in the year that they are paid).

Bad Debts

Bad debts must be supported by a formal written document that spells out the amount of the debt and the schedule for repayment, together with any other relevant details. You will be required to show that you tried to collect the debt, that it was and is uncollectible, and that you’ve sustained a loss as a result.

Insurance

Insurance is deductible as long as it meets the tests of being ordinary and necessary.

Legal and Professional Fees

Legal and professional fees, e.g. to your accountant, are deductible if they are accrued in the course of business. Since October 2004, business owners can deduct a limited amount of legal and professional fees for the first year, then spread the remainder over a period of 180 months.

Taxes

You can deduct a number of taxes, from state tax on gross income to your share of workers’ employment taxes. Personal property taxes and real estate taxes (if used in the business) are generally deductible as well. So are sales taxes for business purchases and excise taxes if ordinary and necessary for running your business.

Employee Compensation

If you employ people including family members, their compensation is deductible, whether workers receive a W-2 from you or, as independent contractors, they receive a 1099. All the costs of employee benefits are deductible, even adoption assistance and educational assistance. Fringe benefits such as airline tickets and country club memberships are likewise deductible.

As a business owner, you will need to stay informed on changes in tax laws that may affect your situation. Visit the IRS website for updates and helpful information – it’s to your advantage to stay on good terms with the IRS.

Note: The information in this article is general in nature, and should not to be considered specific tax advice. Because laws change over time and in different jurisdictions, it is crucial that you consult an accountant regarding tax matters.

Now Hiring in Your Area