The Taxman Cometh
by Zachary Kling
One of the few things that can make such a cold, harsh winter even worse is the looming tax deadline on April 15th. Every year the IRS asks you for their cut, and, as a small business owner, that cut can seriously eat into any profits you have made. There may be deductions you are missing that could ease your tax burden! Below are a few deductions that many small business owners miss out on. Home Office Deduction – Many small business owners are wary of taking this deduction out of fear of being audited, which is always a frightful prospect. However, most small businesses operate out of their owner’s home and many likely qualify for this deduction.
If you have a space in your home that you use regularly and exclusively for conducting business, you might seriously consider taking this deduction. For a great overview and explanation of how to qualify for this deduction, check out Nolo.com’s fantastic article on the subject.
Start-up Costs —If you started your business in the current tax year, you may be eligible to deduct up to $5,000 of qualifying start-up costs and an additional $5,000 of organizational costs. If you have incurred more than the $5,000 limit, you can still deduct $5,000 currently and the rest can be deducted over the next 15 years. However, if you incurred more than $50,000 in start-up costs, there are certain limitations on this deduction.
Business start-up costs include expenses such as investigating your potential markets, advertising the opening of your business, salaries for employees being trained, fees paid to consultants, and travel costs associated with starting the business like traveling to meet potential investors, partners, suppliers, distributors, and customers.
Organizational costs are those costs incurred in the incorporation of your business. So, if you have incorporated your business this year, the business may deduct expenses such as state filing fees associated with the incorporation and fees paid for legal services in connection with the incorporation.
If you would like to read more about these particular deductions, the IRS has published a useful guide to this and other business deductions, which is available at IRS.gov. Section 7 of that document first mentions these deductions and Section 8 goes into more detail on the deductions.
Mileage—The IRS allows you to deduct the expenses associated with using your personal vehicle for business, but this requires keeping good records of such use so that the IRS can’t throw a wrench into your plans to take this deduction. Many business owners miss out on this deduction simply because of the record keeping required to take this deduction and to prove its validity in the event of an audit. Don’t let that be you! With a little bit of record keeping you can deduct tolls, parking fees, and other costs of using a vehicle for business.
There are two methods to account for this deduction: the actual expense method and the flat mileage method.
The actual expense method allows you to deduct all of the expenses you incurred in using your personal vehicle for business. In practice, this requires you to keep good logs of all of the times that you use your vehicle and to then determine what percentage of your use is for business. You then multiply that percentage by the total expenses incurred in operating the vehicle (gas, repairs, insurance, registration fees, etc.) to arrive at your deductible business expense. For most people, that will be a big pain because it requires keeping very good logs of all of your use and all of your expenses; that’s a lot of record keeping! This method is much easier to deal with when you have a vehicle used exclusively for business purposes like a work truck or delivery van.
The second method, the mileage method, requires only that you log how many miles you put on your personal vehicle while using it for business purposes. You then multiply that number by the prescribed per mile rate, which for tax year 2014 is $.56 (56 cents) per business mile, to arrive at your allowed deduction. Note, you can still deduct parking fees and tolls incurred when using this method. The IRS recently announced that for tax year 2015, they will be increasing the standard mileage rate to $.575 (57.5 cents) per business mile. So, if you haven’t been keeping logs of the business use of your personal vehicle, it’s time to start! Read up on this deduction in IRS Publication 463, available at IRS.gov.
Ordinary Business Expenses (And A Couple That May Not Seem So Ordinary or Necessary) — The IRS allows taxpayers to deduct all of the ordinary and necessary business expenses associated with operating their business (see the Internal Revenue Code at Section 162). The IRS says that an “ordinary expense is one that is common and accepted in your trade or business” and “a necessary expense is one that is helpful and appropriate for your business.” For most business owners these deductions should include:
- Telephone – If you have a dedicated telephone line for your business, you may deduct the entire cost of that line. If you use a personal phone to conduct business, you can keep similar records as described above in regards to mileage in order to keep track of the percentage of use your phone is used for business. Then you can deduct that percentage of your phone bills. Lesson to be learned: Get a dedicated line for your business and write it all off!
- Insurance—If you carry any kind of insurance for your business, deduct all of your premium payments!
- Travel Expenses—This deduction requires keeping pretty good records so that you can prove you were truly conducting business on your trip, but, if you travel as part of your business, you should be taking this deduction. You can deduct all travel expenses (including airline tickets), lodging, and meals associated with doing business on your trip. One catch here is that you can actually only deduct 50% of the meals eaten while travelling (the IRS knows you have to eat anyways). For more information on this deduction straight from the IRS, you can check out IRS.gov.
The Internal Revenue Code provides that the deducted meals and lodging should not be “lavish or extravagant under the circumstances”, so don’t buy the $1,000 bottle of champagne and try to deduct it. However, you might think of staying in the slightly nicer hotel now that you know you will be able to deduct it.
If you, like many other people, like to do some personal vacation-type activities at the end of your business trips, then you will need to be able to prove that the primary reason for your trip was business and that you did not deduct personal expenses. Make sure to keep good records that indicate when business stopped and pleasure began, and don’t begin the pleasure portion of your trip until the business portion is finished. In the event of an audit, this will make it much easier to prove to the IRS that you were playing by the rules.
Entertainment – Discussing business during some form of entertainment can be a great way to build a good working relationship with clients, and you may be able to deduct 50% of some of those expenses. To deduct entertainment expenses, the expense has to be 1) ordinary and necessary and 2) able to meet one of two tests the IRS uses in determining eligibility.
The two tests are 1) the directly related test, and 2) the associated test. According to the IRS, the test criteria are as follows (here is a link to the official IRS publication describing these tests and the entertainment deduction generally):
The directly related test requires that you show:
- The main purpose of claimed entertainment expense was the “active conduct of business”
- You actually engaged in business during the entertainment, and
- You had more than a general expectation of income generation or business benefit (i.e. you had specific business to discuss)
The associated test requires that you show:
- The entertainment is associated with your trade or business, and
- The entertainment is directly before or after a substantial business discussion
Check out the publication linked above if you’d like to learn more about how you may be able to deduct the expenses of entertaining clients, suppliers, or distributors.
Of course, these are just a few of the many, many deductions that a small business owner is entitled to take. If you do your own taxes, do your homework and make sure that you’re not paying too much. If doing your taxes is not on your short list of things to do this weekend, I suggest you have a qualified attorney or CPA look over your tax return.
Good luck this tax season! Maybe you can use that refund to get away somewhere warm, or at least turn up the thermostat and pretend!