Expenditures !!!The ultimate tax shelter:
owning your own business
The surest way to reduce your taxes is to convert personal expenditures into allowable deductions. Turn even a hobby into a business and you'll cut your tax bill.
Here’s the best part: Your business doesn’t have to make a profit for your expenses to be deductible. All you have to do is establish a "profit motive." Under the Internal Revenue Code, a "profit motive" is presumed if you earn any net income in any three out of five business years.
It’s recognized and expected that new businesses probably won’t make a profit in the early years. In fact, in the early years, you can insist that the IRS defer any challenge for the first five years as to the legitimacy of your business by filing Form 5213.
The test for deductibility is whether you have an actual and honest profit objective. You need not have a reasonable expectation of a profit. While the Tax Court requires a primary or dominant profit motive, the U.S. Claims Court has held that having a reasonable chance to make a profit, apart from tax considerations, will suffice.
How to qualify as a business deduction!
To qualify as business deductions, your expenses must be: Ordinary and necessary -- defined by the courts and the IRS as "reasonable and customary."
Paid or incurred during the taxable year, and
Connected with the conduct of a trade or business.
The term "reasonable and customary" depends on your specific business and the business customs in your locale. The expenses don’t have to necessarily be reasonable and customary to you, but simply to your particular trade or industry. There are innumerable cases of "hobbies" converted into “businesses” with expenses allowed.
Focus on your profit-making motive. Remember that it’s not what you pay in taxes that counts, it’s what you keep.
You deserve a tax break on your home office costs!
If your home is a place of business, many of your personal expenses can be deducted as business expenses. Here are tips on what qualifies, and how to avoid an audit.
If you use your home for business purposes, many of your personal expenses can be converted into deductible business expenses. For example, when you qualify for an office at home, the following expenses can be deducted:
Your "office" furniture and equipment, on a depreciation schedule. This would include any desks, chairs, computers, couches, lamps or other furnishings that you put into your office. If you buy a sofa for $1,000 and put it in your family room, it costs you $1,000. If you’re in the 31% bracket and you put the same sofa in your home office, the IRS contributes $310 to the purchase of it.
In fact, there is a special provision that allows you to deduct as much as $18,500 in business furniture and equipment in a single year rather than depreciating it over its "class lifetime." (The "class lifetime" is the number of years the IRS prescribes for the depreciation of the item.) This accelerates the value of the deduction into a single year and gives you, rather than the IRS, the benefit for the time value of the deduction. Note that the limit is for the total value of qualifying furniture and equipment purchased during the year, not a per item limit.
Your entire office, also on a depreciation schedule. If you own your home, rather than rent, you depreciate the portion of the acquisition cost (building only, not land) and improvements related to your home office over a 39-year period. For example, if your house is 2,000 square feet in size and you use 200 square feet of it for your office, you depreciate 10% of the cost and improvements to the whole house. If the improvements relate only to the office space, you can depreciate 100% of those expenditures. If your home is rented, you can deduct the percentage of your rent that would be for your office on a similar ratio basis.
It’s important to note that your home office doesn’t have to be the whole room; any part of a room could qualify. In addition, your ratio percentage can be computed on a square footage basis, or, if the rooms are relatively equal in size, on a room basis.
Homeowner’s insurance, utilities and related expenses based on the percentage of their use in the home office. Maintenance also may be deductible. Repairs to your home office are fully deductible while repairs to the whole house would be deducted on a percentage basis. Moreover, don’t forget snow removal and grass cutting. If you qualify for a home office, these expenses would also be allowed on a percentage basis.
The costs for a second phone line. Unless you have a separate line for business, no part of your basic phone bill can be deducted. However, you can still deduct any long-distance business calls, call waiting and call forwarding, and, of course, the full cost of a second line.
Having a qualified home office also allows you a greater auto deduction. Commuting is not deductible. However, with a home office, your commute may be your trip from the bedroom to the basement. All other business trips from your home office may be deductible.
You can deduct 31.5 cents per mile, plus tolls, interest on the business portion of your car (meaning that if you use your car 90% for business, 90% of the interest would qualify) and parking. Alternatively, you can keep track of all of your auto expenses and deduct the business percentage of the total. Indeed, having a home office increases your "business" use of the vehicle.
How you qualify
To qualify for a home office, the portion of the home used as an office must be used "exclusively and on a regular basis" for your business needs. To prove "regular basis," just keep a diary of where you were working. That’s easy. Be careful about the "exclusive" requirement. The IRS may ask you what percent of the time you use your computer for business as opposed to investment purposes. If your computer is fixed in your home office and you use it at all for investment purposes, the IRS may find that you have failed the exclusive test and disallow your whole home office deduction!
There are three qualifying uses for a home office. You must use the area either as:
A storage place for goods sold in your business; or A place of business where you meet patients, clients or customers; or The principal place of your business.
Even if you do most of your work outside the office, but you still use your home office to handle administrative duties, make phone calls and so on, you can qualify for a deductible home office. Prior to the law changing in 1998, it was possible to actually not have a "principal place of business." The new law now makes one of the best ways to cut your tax bill available to thousands of more people.
How to avoid being audited
Your "home office business" doesn’t have to be your primary occupation. Home offices for second or third businesses qualify as long as there is a profit objective to qualify the activity as a "business."
Moreover, you may qualify for a home office even if you are an employee, but only if your employer requires you to maintain an office at home as a condition of your employment. While not required, my suggestion is to get a letter from your employer and attach it to your return. If your return is kicked out by the computer, the attached letter may decrease your chances of being audited. It shows you know the law, proves you need the home office, and tells the IRS you’re ready to prove it. The IRS is hesitant to initiate audits where they feel the chances of additional revenue are small. The letter puts them on notice that if they mess with you, they’re going to lose.
A snapshot of your office
To prove a home office, have its address on your business cards and stationery, keep a log of who you see, when you use the office, and what you do. I recommend that you even have someone photograph you in your home office holding up a newspaper to prove the date, and all of the contents of your office.
Remember, if you claim a home office on your 1999 return, you can be audited any time through April 2003 (there is normally a three-year statute of limitations). During those three years, you may move, discontinue the business, or even just discontinue the use of a home office. Nevertheless, the deduction was legitimate for 1999. Having a photograph makes it much easier to prove.
Deducting your car expenses !!!
Your car can be a tax deduction, but there must be a direct relationship between the use of the car and your business or some income-producing activity.
Turn your vehicle into a tax deduction. If you use your car or truck for business-related trips, to deliver food to your favorite charity, or even to drive the kids to the doctor’s office, you can deduct at least some of the costs.
Automobile expenses incurred in your business travel are deductible either as a travel expense or as a transportation expense. (Transportation expenses are deductible only if they’re incurred in a business or investment situation.)
To get the deduction, there must be a direct relationship between the use of the car and your trade, business or some income-producing activity. Examples might be driving to see some property you own or talking with a broker about your investments. If you have one car that you use both for personal and business use, only deduct the portion of your car expenses directly attributable to business use.
The mileage cost basis
In allocating your car expenses between business and personal use, there are two methods you can use. The first is the mileage cost basis. Using this method, you multiply your business mileage by a standard mileage rate that is set each year by the Internal Revenue Service. For 1999, that rate is 31.5 cents per mile plus parking fees, interest, taxes and tolls.
So, for example, if you drive your car 10,000 business miles over the year, you can deduct $3,150, plus all of your business expenses for parking fees, interest, taxes and tolls. You cannot use the mileage cost basis if you use two cars simultaneously in the same business. It is allowable, however, if you use each car for a separate business.
The mileage percentage basis
The second method is the mileage percentage basis. You divide your business-related travel by your total mileage and take that percentage of your total expenses as a deduction. So, for example, if you drove 20,000 total miles over the past year and 15,000 of them were business-related, then 75% of your auto expenses would be deductible.
Included in such auto expenses are any interest, taxes, gas, oil, repairs, washing, registration, license fees and depreciation you incurred. Your business expenses such as parking fees and tolls are 100% deductible and are treated separately from the 75% calculation.
There is a special tax planning strategy that you can use if you have two cars in your family. Assume that you’ve been using one car exclusively for business and the other exclusively for personal family use. You put 36,000 miles each year on your business car and only 12,000 miles a year on your personal car. Typically, you could only deduct the costs of using the business car.
Now suppose you switched the use of each car every six months. The combined mileage of both cars remains 48,000 miles a year. But by rotating your cars equally between business and family use, each car could have 75% of its expenses deducted for tax purposes. Here’s how it works: Both cars are driven 24,000 miles, but 18,000 of those miles are business-related. So instead of only deducting the costs associated with one car, you get to deduct 75% of all of your expenses on both cars. If you’re like most people, that will save you several hundred dollars a year in taxes.
Deduct your "temporary work location"
There is even a way to deduct some of your routine work commutes. Typically, you can’t deduct the cost of commuting to and from work. However, if you have a regular place of business, you can deduct the daily transportation costs of traveling from your home to a "temporary work location." A temporary work location is any locale where you perform services on an irregular or short-term basis. For example, daily transportation expenses incurred by a doctor traveling between a clinic and a hospital or between the doctor’s residence and a temporary work location could be deducted as business-related. Alternatively, an executive or salesman who makes infrequent visits to customers or clients at their offices may deduct those expenses.
Consider a Jeep for your business car
Executives or business owners also may want to think about trading in their luxury sedans for sport utility vehicles, because of the way the tax laws are written. Sport utility vehicles that weigh more than 6,000 pounds (like a Chevy Suburban or Toyota Land Cruiser) aren’t considered "cars" by the IRS. That means you can fully depreciate those vehicles in just five years compared with luxury cars that have a maximum depreciation level of $14,460 over the same period.
If you have a home office, expenses incurred in getting from your home office and other job sites can be deducted. Your "commute" from the bedroom to your home office is the only portion not deductible.
Get back what you paid for your car
The deduction for transportation expenses may potentially reduce your net cash outlay for a car to less than half its cost. For example, let’s see what happens if you’re in the 31% tax bracket and bought a $6,000 car (it’s used, OK?) and used it solely for business purposes. You can claim the first $1,700 as a business expense and choose a five-year depreciation schedule. If you drive 30,000 miles in the first year, your net cost for the acquisition drops to less than half. This is a potential expense scenario:
Cost of car: $6,000
Minus election to expense: $1,700 x .31 ($527)
Minus depreciation: ($6,000-$1,700) x .20 [five years]) x .31 ($267)
Thus we get the net cost of the car -
Net cost of car: $5,206
Minus expenses -
Fuel: 30,000 miles @ 10 mpg=3,000 gallons @ $1.25/gal=$3,750
Repairs, oil, and upkeep: $900
Insurance: $1,210
Garage rent, license, registration: $750
Tolls, parking, interest on auto loan, etc.: ($6/day) $2,190
Add these up to get total expenses -
Total expenses: $8,800
Your tax savings at your marginal rate is -
Tax saving: ($8,800 x .31) $2,728
And your final net cost totals -
Final Net Cost: ($5,206 - $2,72 $2,478
While the above numbers have been simplified, what I want you to recognize is that your car can be a valuable source of tax-saving dollars.
If you have a car that is used 75% of the time for business, everything related to that car would be 75% deductible. That would include your new CD player and the dice you hang on your rear view mirror.
Focus on our objective here. If you can convert personal expenses into business expenses and are in the 28% tax bracket, you have, in effect, created a 28% discount on the cost of anything that qualifies as a business expense.
Your Vacation Deductable ??? You can combine business with pleasure, and deduct it, too!
The IRS says you can deduct expenses for taking a business trip or business convention. And there’s no reason the trip shouldn’t coincide with your vacation.
There is no law prohibiting you from combining a business trip with a vacation. And if you do mix and match, don’t forget to keep your receipts. I can't stress this enough. You must save receipts!!!
The Internal Revenue Service concedes that you’re entitled to deduct expenses for taking a business trip or attending a business convention. While such trips must benefit or advance your business to qualify as a tax deduction, there’s no reason why the trip or convention couldn’t coincide with your vacation. Why do you think that most large conventions are held in cities like New York, Palm Springs and Miami?
What’s involved
Convention and business travel expenses are deductible to both employees and the self-employed. Such expenses would include convention costs, hotels, meals and entertainment, and travel expenses to and from the convention. If a business purpose can be established, the expenses of your spouse may also be deductible. The business conventions or seminars must specifically relate to your business or profession. This rule could be called the "resort investment seminar" rule.
The IRS specifically says you can’t deduct the expenses for attending an investment or financial planning seminar in a resort area.
Rules vary on domestic, foreign travel
The deductibility rules differ depending on whether the trip is within or outside the United States, and whether it’s a foreign convention or a cruise convention. We will examine each:
I would recommend that if you’re going to visit a client, you should write to this person and receive in return a letter confirming the planned visit to discuss business matters. That letter validates the business purpose of your trip.
Factoring your business time
The amount of time that you spend on business will be a factor in answering the question of whether the trip was mostly for fun or work. For example, if you spend five days conducting business and three days sightseeing and seeing shows, the trip will be considered primarily for business and all of your transportation will be deductible.
Alternatively, if you conducted business for two days and enjoyed the sites for the remaining six days, the trip would be considered primarily personal and no transportation expenses would be allowed. It’s important to recognize that travel days count as business days in the "primary" computation.
Even if the trip is mostly personal, any expenses you incur that are mostly business-related -- meals, lodging or incidental expenses, for example -- can be deducted.
If the trip is outside the United States, as defined by the IRS to include Canada, Mexico, the Pacific Islands and certain Caribbean countries, special allocation rules apply. If you were out of the country for seven days or less, or if less than 25% of your trip was spent enjoying the scenery, you don’t have to follow the special allocation rules. Furthermore, no allocation is required if you had no substantial control over the trip arrangements and if the desire for a vacation was not a major factor in taking the trip.
Alternatively, if the trip was primarily for pleasure, none of the transportation expenses will be deductible. In all other cases, all travel expenses must be allocated between business and personal expenses (with travel days counting as business days).
For example, assume you took a trip from New York to London primarily for business purposes. You were away from home July 20 through July 29 and spent three days vacationing and seven days conducting business (including two travel days). Suppose your airfare was $500 and your meals and lodging amounted to $75 per day. You could deduct 70 percent of your transportation expenses (seven out of 10 days) and $75 per day for seven business days, as you were away from home for more than seven days and more than 25% (three out of 10 days) of your time was devoted to business. (Remember that only 50% of your meals would be deductible.)
If your trip is subject to the allocation rules, there is a planning strategy to maximize your tax deduction. When booking your flight, if you can, arrange for a stopover within the United States at the point closest to your destination. That way, the portion of the trip between your home and the stopover point will be fully deductible. You will then only have to allocate the cost of the remainder of the trip.
Foreign conventions
Further restrictions are imposed on foreign conventions. No deduction will be allowed for expenses attributable to a foreign convention unless it is "reasonable for the convention to be held outside North America." In other words, you can’t deduct the trip if you can’t show it had to be over there rather than over here. Note here that we’re only talking about conventions. These rules don’t apply to other foreign business meetings. Three factors are considered in determining the reasonableness of the convention location:
The purpose of the meeting and the activities taking place at the meeting;
The purpose and activities of the sponsoring organization or group;
The residence of the active members of the group and where prior or future meetings will be held.
While there is no limit on the number of foreign conventions/vacations you can attend and deduct on your taxes, the rules change if you try to do it on cruise ships. Uncle Sam has a hard time understanding how serious conventions are when held aboard luxury cruise liners, unless:
The convention or meeting is directly related to your trade or business;
The cruise ship is U.S. registered;
All ports of call are located in the United States or its possessions.
Even then, the maximum deduction is $2,000 for each taxpayer and you must attach two written statements to your return. The first statement, signed by you, must include information as to the number of days that were devoted to scheduled business activities. The other, signed by a representative of the sponsoring organization, must include a schedule of the business activities each day, and the number of hours you were in attendance.
Remember that the key to deducting your vacation as a business expense is prior planning. Make sure that you can substantiate your business purpose for the trip and your expenses. Properly planned trips that combine business with pleasure will allow you to deduct the cost -- or at least a portion of your cost -- for nearly everything you do.
I have found that perhaps the easiest way to maintain a record to prove you really did work on that trip to Tahiti is to keep a diary or account book of such expenses. After all, if you’re in the 31% bracket, a $10,000 business and vacation trip would be subsidized by the IRS to the tune of $3,100!
Entertainment !!!
IRS rules for business-related meals, entertainment and gifts allow you substantial opportunities to convert personal expenses into deductions.
How? Tax laws allow you to deduct half of your meals and entertainment expenses if they’re business-related. Any expenses for food and drink provided under circumstances considered favorable to a business discussion, or when a business discussion is held, can be deducted. If you’re self-employed, you can deduct them as part of your adjustments to income. If you’re an employee, you add them to your miscellaneous deductions.
You can also deduct up to $25 for each business-related gift given to a client or business associate during a tax year. You'll need to keep the receipts as proof, but the result can save you at tax time, particularly if you typically send several gifts at holiday time each year.
Entertaining business clients
By far, the most commonly used aspect of this deduction relates to entertainment and food, however. The custom of entertaining business clients or potential business clients with food and drink in restaurants and hotels converts your personal feeding frenzies into deductible expenses. When you go out with friends or relatives for a meal or drink, do you ever pick up the check? If they are or could be potential clients or customers for your business, and you discussed business with them, then that check would be deductible.
Even if you don’t talk business at the meal, it will be deductible if the meal follows or precedes a bona fide business discussion. Recognize that no actual business need come from the meeting so long as business was discussed. Now don’t use this method as a way to alternate who pays for lunch or dinner with your best friend. Any "regular" exchange of meal checks, if caught by the Internal Revenue Service, will be disallowed as a sham in an audit and subject you to fraud penalties. However, don’t hesitate to deduct legitimate expenses.
Moreover, not only can you deduct meals, but you can also deduct business entertainment expenses. Money spent for business entertainment, amusement or recreation can be deducted if you can show the expense:
Directly preceded or followed a substantial bona fide business discussion; or;
Directly related to the active conduct of your trade or business.
Examples of potentially deductible expenses include entertaining guests at nightclubs, theaters, sports games, or even vacation trips. In one case, an anesthesiologist was allowed to depreciate his fishing boat and deduct the expenses for entertaining doctors on the boat who were his referral sources.
For meals and entertainment, you must substantiate the following:
The amount of each expenditure;
The date of the expenditure;
The name, address or location, and type of expenditure, such as dinner or theater, if the information is not apparent in the name or designation of the place;
The reason for the expenditure or the business benefit derived or expected to be gained. While this sounds complicated, it’s really easy. If I sold insurance, my reason would be to either get a new client or to sell more insurance;
The occupation or other information about the person or persons entertained, including the name, title or other designation sufficient to establish the business relationship to you.
You must have a receipt or other documentary evidence for meals or entertainment expenses of $75 or more. Currently, for expenditures of less than $75, you do not need a receipt. Fully acceptable substantiation would include a diary or written planner in which you enter the above descriptive information. Those diary entries are all you would need. Even in an audit, the entries are complete substantiation under the law.
While most meals or entertainment expenses can only be deducted for half of the cost, certain meal and entertainment expenses remain fully deductible:
Expenses treated by an employer as compensation to an employee;
Expenses reimbursed under an "accountable plan;"
Expenses incurred for recreational or social activities provided by the employer for the benefit of its employees. These might be the annual company picnic or holiday party;
Expenses for goods, services and facilities made available to the general public, such as promotional tickets or customer samples;
Expenses related to the ticket package costs for sporting events arranged primarily for the purpose of charitable fund-raising.
The deductions for meals and entertainment allow you substantial opportunities to convert your personal expenditures into business deductions.
Do not fail to claim them and do not fail to keep them because of lack of adequate substantiation. In the 31% tax bracket, $100 worth of football tickets costs you $84.50. No matter how much money you’re making, it would be worth $15.50 in tax savings to spend 30 seconds noting the name of your business clients and the business discussion on the back of your ticket stub.
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$2,478