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