Make the most of deductions
No doubt about it. Tax rules and terminology are confusing and
when tax time comes, small-business owners want every possible
deduction coming to them without running afoul of the IRS.
Fortunately, the IRS knows that business owners have to spend
money in order to make money. The more deductible expenses you
have, the less you pay in taxes.
The trick is in recognizing what’s a de-duction and
what’s not — and in keeping the right records.
Stakes are high, so you’ll want to get it right: IRS
audits are way up. In fact, while IRS audits overall jumped 20%
in 2005, audits of small incorporated businesses more than
doubled.
Meanwhile, complicated, ever-changing rules are causing
entrepreneurs to unnecessarily deliver too many of their
hard-earned dollars to Uncle Sam.
“When you incur business expenses, you get tax
deductions and save money on taxes,” says tax attorney
Stephen Fishman. “But those deductions are only as good
as the records you keep to back them up. Any expense you forget
to deduct, or lose after an IRS audit because you can’t
back it up, costs you dearly.” Each $100 in unclaimed
deductions costs the average taxpayer another $43 in taxes.
Fishman says a basic record-keeping sys-tem should include a
business checking account, appointment book, expense journal
and support documents such as receipts. You’ll need to
track income, and also inventory if you make or sell
merchandise. And if your business has employees, you need
complete payroll and payroll tax records.
Here are some of the prime categories for small business
deductions:
1) Startup expenses: Some of these costs can be deducted
immediately; others over 15
years. “However,” notes Fishman, “a special
tax rule allows you to deduct up to $5,000 in startup expenses
your first year in business.”
2) Business operating costs: These include all of the
“ordinary and necessary” expenses you incur that
are related directly to operating your business.
3) Hired help: This includes money you spend on independent
contractors as well as employees. Be sure to follow IRS rules
on who qualifies as an independent contractor.
4) Travel and entertainment: Tax laws recognize that business
is often done at restaurants, on the golf course or elsewhere
and allow you to deduct a portion (usually half) of
“entertainment” costs. Costs for overnight business
travel are also deductible, although the IRS looks closely at
this area.
5) Vehicle expense: Local business-related travel costs are
another valuable deduction. This includes business use of your
car and can be claimed as a per-mile rate set by the IRS. Keep
records — this is another red-flag area for auditors.
6) Retirement and medical deductions: Contributions to
qualified retirement plans are a terrific small business
deduction. Plus, there are several ways to deduct the cost of
health insurance premiums, depending on your business
structure.
7) Inventory: This is tricky tax territory for small
businesses. Inventory costs are not handled like other
operating expenses. As Fishman, the tax attorney, notes,
“A business may deduct only the cost of goods actually
sold during a tax year — not the cost of its entire
inventory.” Unsold items are considered an asset, not a
write-off.
Other possible deductions include training costs, business
gifts, association dues, advertising, bad debts, fees,
licenses, insurance and interest on business loans.
— Daniel Kehrer, BizBest Media
