Tax Tips for Small Business Owners

How to LEGALLY reduce your tax liability

It always surprises me how little many small business owners know about taxes. Admittedly it's not the sexiest topic of conversation, but one you really need to know something about if you're running a business.

For starters, you might be surprised at how many of your expenses you can legally deduct, which can save you money!

Hundreds of books about small business taxes have been written, and I've read dozens of them. Although I'm not a tax or financial professional, I have been running a small business for nearly 20 years and I can comfortably recommend two highly reliable tax resources…

Eva Rosenberg a.k.a. Tax Mama

–and–

Sandy Botkin

Eva and Sandy are each respected tax pros can help you to legally maximize tax savings and organize your records to protect yourself against potential problems with the IRS and other tax agencies.

Regardless of the stage you're in with your business, you are required to report all of your income to your federal and state tax agency. So you need to make certain that you understand, organize and plan how you'll handle your taxes.

Here are some helpful tax tips and suggestions…

Accounting fees…

If you paid a bookkeeper or accountant for services related to your business, those expenses are tax deductible.

Advertising.

Deductions for advertising include…

Pay-Per-Clicks and other paid Internet advertising.
Flyers, post cards, mailers and brochures.
Business stationary such as business cards, letterhead and envelopes.
Newspaper, magazine, and radio ads.
Yellow pages, newspaper, magazine, and ezine ads.
Signs and billboards.
Promotional items with your business name printed on them such as pens, key chains, t-shirts, etc.

Bank Fees (business account) — Safe deposit boxes, bank overdraft fees, and other incidental bank charges are all deductible.
Bookkeeping costs — Costs associated with payroll services are deductible.
Computer supplies and peripherals — Ink cartridges for printers and fax machines, portable hard drives, RAM upgrades, USB cables, mouse pads, etc.
Continuing education costs/seminars — Educational expenses incurred as part of your existing business are deductible.
Delivery costs — The costs associated with shipping your product or delivering your service is deductible except for those costs that you recover from your customers.
Entertainment costs — Although a certain portion of entertainment expenses are deductible, be careful with these deductions. Be sure to educate yourself and consult with your accountant.
Equipment — The cost of maintaining equipment used in your business, whether rented or purchased, may be deductible.

(I suggest that you consult your accountant about this issue because equipment deductions may fall under capital improvements rather than business equipment expenses.)

Facsimile costs — Costs associated with sending or receiving faxes are deductible.
Insurance premiums — Insurance premiums for casualty, inventory, credit, business interruption, overhead payment, vehicle, employee medical, workers' compensation, state unemployment, liability (all different types), and even some types of life insurance on key employees (so long as you are not the beneficiary) are all possible deductions.
Interest expenses — This relates to interest on loans for your business. As long as the loan is for your business, the interest you pay is deductible.
Internet access/Web hosting fees — If your business has a reason to be on the web, or if you need access to the web as part of your business, then deduct away!
Legal fees — Any legal fees arising from managing your business or producing or collecting income are all deductible.
Licenses — Any license or regulatory fees paid to governments as part of your business are deductible.
Office supplies — These expenses include pens and pencils, paper, file folders, calendars, staplers, letter trays, etc.
Postage — Stamps are deductible. Keep your receipts.
Rental payments— If you rent office or storage space for your business, the expenses are deductible.
Repairs and simple maintenance — Expenses related to your business site are deductible. But once again, this is an area that may fall under capital expenses, so be sure to consult with your accountant for guidance.
Subscriptions — Subscriptions for magazines, periodicals and newspapers that relate to your business are deductible.
Travel — Deductions for travel expenses carry very specific rules. You must be able to prove that travel expenses were actually related to your business. For example, if you take a Caribbean cruise and then deduct the cost as a business expenditure, you had better be able to prove that trip was indeed related to business. Keep track of hotel and car rental receipts, as well as meals, transportation costs, etc. Not all of your expenses are deductible, i.e., dry cleaning. Consult with your accountant for guidance.
Utilities — You can deduct a pro-rated portion of your utility bills for a home business, as long as you maintain a separate space that is used exclusively for your business, i.e., a spare bedroom. If you use a corner in the living room or the dining room table as an office, you can't take this deduction.
Wages — Wages paid to employees are deductible. However, this is another area where specific rules apply. Consult with your accountant for guidance.

General Rules for Small Business Tax Deductions

There are certain threshold issues that apply to all small business and home business deductions.

Appropriateness of the expense. Was the expenditure ordinary and necessary for your business?
Relation to a business activity. The IRS is keenly aware that taxpayers may be tempted to write off expenses against their business that are actually nondeductible personal expenses. If the expense was only partly for business, you'll need to allocate it between the business and personal portion.
Do you have adequate records. In a tax audit, the IRS agent will ask you to show that the expense was in fact paid. This is where your record keeping comes into play. If you have kept good records, proving your deductions won't be a problem. Remember, on most tax matters, the IRS can require you to prove that your deduction (or other item on your personal or business return) is legitimate. If you can't do this, the IRS will disallow the deduction and your tax liability will increase.

Potential Tax Deductions for Small Business

Deductions for business expenses depend upon your ability to prove a PROFIT MOTIVE. You are NOT in business unless you are trying to produce a profit. If you are conducting business in order to make a profit, you are allowed to deduct "ordinary and necessary" business expenses.

The key to maximizing your deductions is thorough and complete documentation. If you can't prove that the expense was actually incurred, it's likely the expense will be disallowed.

GENERAL SUGGESTIONS

In order to prove that you are conducting business for profit rather than as a hobby, you need to create a paper trail that will validate your business activities.

Maintain a business checking account separate from your personal account.
Use a separate business credit card. Keep copies of charge card receipts for travel, entertainment, and gas and oil purchases. Both the interest and annual fee is an allowable business expense. Also, pay the credit card bill with a check from your business account.
Install a separate business phone line. Your primary home line is NOT a deductible business expense but a second line may be.
Keep copies of any ads and flyers that you create, or have made by an outside source, in order to validate that your business is real and in pursuit of profit.
Document your expenses in your calendar or planner DAILY.
Copies of checks are NOT enough. You must also have receipts.

ENTERTAINMENT

Beginning in 1994, the tax code began limiting most entertainment expenses to 50% of the amount spent.

Receipts are not required for entertainment expenses under $75 per expense.
In order to deduct the cost of meals, business must be discussed during the meal. Surroundings MUST be conducive to a business discussion.
Who, What, Where, When and Why…

You can deduct a portion (50%) of the following expenses as "associated entertainment" as long as you document them properly…

Theater, Symphony, Ballet, Opera
Sporting events
Golf
Hunting Trips
Fishing Trips
Ski Trips

Here's an example of proper documentation…

Symphony preceded by business meeting

–OR–

Symphony followed by business meeting

Limits on customer and colleague gifts is $25 UNLESS you’ve documented it as an associated entertainment expense, in which case there is no limit.

BUSINESS MEALS

You MUST be there!

Your spouse can be included in the meal along with your business contact, as long as business is discussed during the meal.

You can even deduct a portion of meals that are "Dutch Treat" — as long as business is discussed during the meal.

HOME ENTERTAINMENT

Home entertainment expenses are allowable deductions IF you discuss business and IF you document who and why. IF your home entertainment revolves around a sales seminar, formal presentation, or a workshop, refreshment expenses can be increased to a 100% deduction.

To ease documentation requirements, keep parties small… fewer than 12 people.

Photograph product displays as part of your documentation to prove business was actually conducted.

CLUB DUES AND GROUP MEETINGS

You can deduct business club dues, and meals consumed at association and/or organization meetings provided they are "ordinary and necessary" for your business. They must be meant for networking and making contacts that are vital to your business. Just make certain to document who you made contact with and note it in your calendar or planner.

TRAVEL

According to the IRS, you are "traveling" when you are away from home, overnight, or for a period of time sufficient to require sleep.

On-the-road expenses include…

Lodging
Meals
Laundry and/or dry cleaning
and whatever else would be required to sustain life while traveling

One additional note about dry cleaning — clothes soiled while traveling and then dry cleaned after you return home can be counted as an expense. Keep your receipts and write notes on them referring to the travel with which they are associated.

Receipts are NOT required for travel expenses under $75 per expense with the exception of LODGING.

Travel expenses can become 100% deductible with the exception of meal costs.

To Increase Travel Deductions…

Hire Your Spouse. Not only can this enable you to increase your travel deductions, but doing so can also impact health insurance deductions.
Drive the car you use in business car for family travel. Regardless of the presence of family members, you would be using that car for business anyway.
Deduct your portion of food and lodging.
Take U.S. Cruise Ships — they're the only ones eligible for tax deductions
Make weekends deductible — Schedule Friday and Monday meetings… the weekend expenses becomes a write-off
Days spent in transit count as business days.
Visit colleagues when out of town and make a notation of the visit and of your business discussion(s) on your calendar or planner.
Get educated out-of-town

To Audit-Proof your Travel Deductions…

Lodging receipts are REQUIRED.
Receipts for all expenses in excess of $75.
If you don't keep good records, you'll also need receipts for expenditures of less than $75.

HIRING FAMILY MEMBERS

Hire your spouse in your sole proprietorship, and pay him or her at least minimum wage.

Employing a spouse can increase your deduction for health insurance and medical expenses to 100%, based upon how your "employee" benefits plan is set up.

The IRS allows a self-employed individual to hire their spouse and elect Family Coverage under a Self Insured Medical Reimbursement Plan. Consult your tax advisor for details on how to make this work for you.

Employ your dependant children who are over age 7 and under age 18 in your small business (sole proprietorships). The first $4,400 you pay them is tax-free to that child and you can deduct those wages as a business expense. According to the IRS, single tax-payers receive a standard deduction of $4,400 and then pay tax on the first $26,250 in taxable income at the 15% rate.

Example: You pay your child $4,400 in wages for the year. You deduct the $4,400 in wages on your Schedule C. You pay no social security or unemployment taxes. Your child reports the $4,400 as income from wages on IRS Form 1040 and then deducts $4,400 as his/her standard deduction.

What does this benefit you? In effect, Uncle Sam underwrites the education, weddings, and other uses to which your children could put that money you have paid them.

Documentation…

A weekly time sheet must be maintained in order to prove that actual work was performed.

Pay family members with a check written against your business account.

There are numerous tasks that children can perform for a small business or home business, so hire them to help you… it's a true WIN-WIN situation.

AUTOMOBILE EXPENSES

Document expenses thoroughly. Poorly documented expenses runs the risk of being disallowed.

Remember… Who, What, Where, When and Why.

Record mileage when you start and again when you stop.

Repairs and Maintenance…

Depreciation — Limits on luxury vehicles can be avoided if the vehicle weighs in excess of 6,000 pounds.

You may be able to claim a loss when you sell your vehicle, thereby having an impact on your decision whether to sell or trade-in your vehicle when you buy a new one.

Sell cars that produce deductible losses — trade cars that produce taxable profits. Claim the appropriate percentage of your losses or gains on the business usage of the vehicle only, not the entire value of the car.

HOME OFFICE DEDUCTIONS

You may only take a home office deduction if it is your principal place of business. Photograph your office to document that it is, indeed, used exclusively for business. To determine the deduction percentage of the allowable expenses, divide the total square footage of your home by the total square footage of your home.

Example:

Home Office = 144 sq ft

Total Home = 2000 sq ft

144 divided by 2000 = 7.2%

Your home's square footage can be verified using blueprints or drawings.

Deduct 7.2% (or whatever your home office percentage is) of your mortgage and/or rent, maintenance costs, basic utility expenses, etc. Good record keeping is essential.

Prominently display your home office phone number and address on your business cards.

The primary phone line into your home is NOT deductible. However, long distance charges can be if well documented.

Legally REDUCE Your Income Tax »

One of the best self-study tax courses I have ever taken is one created by Sandy Botkin of the Tax Reduction Institute. His experience as a former trainer of IRS auditors and as a tax attorney makes him a tax expert.

It is also important that your find an accountant or CPA who is knowledgeable about small business and home based businesses. Many are not and, as a result, could miss important allowable deductions.

Log on to the IRS website and request all manuals and documentation they have related to home office tax deductions. There's a lot of FREE information available from government offices that will help you enormously.

Get free IRS tax information »