Owning a Small Business
Owners of small businesses are audited much more frequently than taxpayers who don’t own businesses. So it could pay to be a little extra careful when you file your return.
At the same time, don’t overlook deductions to which you’re entitled. No one gets a medal for paying too much. Taxes are an expense of doing business. If you expend time and effort (and even money) to hold down other expenses, you should be willing to do the same to hold down your taxes.
Businesses are terribly diverse, so there are thousands of things you can do. Here are a few to get you started. If that’s not enough, check out the taxes section of the Business Owner’s Toolkit, which is found on the Web site of CCH Inc., a publisher of tax and business information located in north suburban Chicago.
Keep good books and recordsIf you get called for an audit this will save you. It’s good business practice anyway. So do it, or hire someone to do it for you.
Deducting for space -- your home officeEvery business is entitled to a deduction for the space it occupies (unless that space is free). The expense can take the form of rent if you lease space. If you own, there’s interest, taxes, insurance and depreciation.
Running your business at home throws a bit of a monkey wrench into the works.
You can’t just spread out on the kitchen table at home to maintain the deduction. You have to have a dedicated area where you do nothing but your business. Then, figure out what fraction of your house is taken up by your office. Multiply that fraction by your home expenses (rent, interest, taxes, insurance, depreciation, etc.) and that’s your deduction.
If you qualify.
Setting the space aside is not enough. It must be your principal place of business. Just doing record-keeping for work you do out in the field doesn’t count, unless there is no other fixed location of the business where you conduct your administrative or management activities. The rules used to be more strict on this point but were liberalized beginning in 1999. So dont overlook this tax savings opportunity just because you once failed to qualify.
You also can qualify for the home office deduction if you meet customers or clients in your home. Special rules apply if you run a day care center or store inventory in your home.
Equipment and furnishingsYou can deduct these, often in full, when you get them. Larger businesses find themselves delaying these deductions and spreading them out over a number of years. It’s called depreciation. But you can skip depreciation on up to $20,000 worth of equipment and furnishings and write them all off in the first year. The $20,000 amount will increase to $24,000 for 2001 and 2002 and to $25,000 thereafter.
Cars and listed propertyCars, cellular phones, computers, video equipment and similar items that can be used for nonbusiness purposes (called listed property) are subject to special rules that force you to limit personal use or lose favorable deductions. If you use these items in both ways be sure to keep careful records.
For your car, the records are mileage records. Note the date, the odometer reading and the business purpose for each trip. For repetitive, routine trips, you can just multiply the single-trip mileage by the number of trips. For the other types of listed property, time records are probably the best.
Computers that are used in a qualified home office are not subject to listed property limits.
Cars are subject to additional “luxury car” limits on depreciation deductions. The maximum you can write off for a car placed in service in 2000 is $3,060. Most cars will be subject to this restriction, not just luxury cars. Leased cars are subject to comparable limits.
Liberalizing the rules for deducting a home office, when they come into effect, will have an important side effect. If your home is treated as your principal place of business for tax purposes, your car travel from your home to other business locations is deductible. This is not true for regular commuting. It is true only for travel from one business location to another, so it is a big plus to have your home treated as a business location.
According to small business analyst Susan Jacksack of CCH Inc., “Business owners may find that the additional auto expenses they may claim, as a result of having the IRS recognize their home office, are even greater than the home office deduction itself.”
Operating expensesThis includes supplies, utilities, business services, salaries and all the ordinary and necessary expenses of running your business day to day. If you are operating in your home, get a separate phone line, because you can’t deduct basic service otherwise. And while you’re at it, get several. You’ve got your computer and fax to connect as well.
SalariesIf you are paying for occasional work, you can hire people on an independent basis and skip employment taxes and all sorts of recordkeeping and reporting.
When it starts to become regular work or you are exercising a lot of control over the work, you’re going to have to start treating the person as an employee. That might be the time to get help. The IRS doesn’t like you to fool around with employees, so find out your obligations.
InventoriesIf you’re manufacturing things or selling things, you may have inventories -- either of supplies or finished product or both. This introduces a new complexity into your tax life: keeping track of it all. The rules can be complicated. So, this is another place you might need help.
Meals, entertainment and travel:This is another one the IRS doesn’t like. You have to keep excellent records to support these deductions. One part of the record must be the business purpose. To qualify, you must conduct business over the meal or entertainment or it must follow or precede a substantial business meeting. Only 50 percent of meals and entertainment expenses may be deducted.
Travel is another story. The rules are somewhat less rigid. You have to conduct business, but if you’re away from home, the expenses of the trip are fully deductible (meals and entertainment are still subject to the same rules).
There are all sorts of nuances that can apply in this area. There are rules that divide up expense of a trip if you combine business with pleasure or if you take your family along. There are special daily rates that you can use instead of actual meals and lodging expenses. And so on. Check it out.
Setting up retirement, health and other benefit plansThe tax law smiles broadly over employee benefits. So what if you are the only employee? You can sock away a lot of money tax-free if you take advantage. You can pick up qualified personal expenses (health insurance, for example), again, tax-free. The plans are complicated and you’ll have to cover other employees when you expand. But, if you are doing well, it’s worth it.
Passing the business to your heirs:The recent change to the federal estate tax allows you to pass up to $1.3 million of a family-owned business to your heirs without paying estate tax. Many entrepreneurs have most of their wealth tied up in their businesses. Without a break like this, the business would have to be dismantled to pay the tax. The rule applies to farms as well as to small businesses.
