Tax laws can be so complicated that small business owners are often afraid to take deductions for fear Uncle Sam will come “a knocking.” But fear and ignorance are not good reasons to cheat yourself and not take legal deductions.
“You have to stay abreast of the current changes to maximize their intended benefits,” says Neil Fino of Fino & Associates in Milton, N.Y. “There is a lot at stake, so it’s a good idea to consult a qualified tax professional to make sure you are not missing anything.”
Following are 12 tax deductions that many small-business owners either forget to take or don’t fully capitalize on.
1. Home Office
Operators are often concerned that claiming a home- office deduction can send up a red flag to the IRS and can trigger an audit. But a home-office deduction is perfectly legal.
Just be sure to use “home office” the way the IRS has intended. Trying to deduct the entire den because there is a business phone and computer in it could get you in trouble, or if other family members use the computer for other reasons that could be a problem as well.
You can deduct a portion of a room where your home office is located. Just measure your work area and divide by the square footage of your home. That percentage of your home-related business expenses can be claimed, including rent, mortgage, insurance, electricity, etc.
“Even if you lease a garage to store your business vehicles, it does not automatically prevent you from taking a home-office deduction, as long as you can prove your administrative or management activities are substantially performed in the home office,” Fino says.
2. Travel, meals, entertainment and gifts
The entire cost of a hotel stay is tax deductible. The cost of travel (air, rail or auto) is 100 percent deductible, as are associated costs while on the road, such as dry cleaning, rental cars and tipping chauffeurs and bellhops. You may want to remind your clients of this fact.
The only exception is eating out. You can deduct only 50 percent of your meals while traveling.
At home, your on-the-job meals are not deductible, unless you bring a client along to discuss business.
The 50-percent deduction limit applies to most other client entertainment expenses, although a gift to a client or employee is 100 percent deductible, up to $25 per person per year.
3. Insurance Premiums
Since 2003, the deductible on health insurance was raised to 100 percent, up from 70 percent the year before. Keep in mind the deduction can’t exceed your business’ net profit.
It is also disallowed if you were eligible for other health care coverage, including coverage offered by your employed spouse’s medical plan.
If your spouse worked for you last year, you can get the full medical premiums deduction on your return. As an employee, your spouse’s premiums are 100 percent deductible. If you and the children were on her policy as dependents, so are those costs.
Your spouse’s employment must be real, not in name only, and you must offer equal coverage to other employees. Failure to meet these requirements could result in a lawsuit, an audit or both.
You can get a credit against your personal income taxes for some of the premiums you pay for long-term care insurance for yourself, your spouse or dependents in some states. The 2004-2005 New York State budget allows a 20 percent credit against income taxes for the cost of long-term care insurance premiums, Fino says.
“Depending on how things are wrapping up at the end of the year, I sometimes pay my insurance forward for the coming year,” says Scott Woodruff of Majestic Limousine Service in Des Moines, Iowa.
4. Office supplies
All office supplies used in a trade or business are deductible as an operating expense, even if you don’t take a home-office deduction. Hang onto your receipts. These expenditures can help offset your taxable business income.
“We advise our clients to save all their receipts, even if they are unsure whether they are deductible,” Fino notes. “Let us determine if the item was truly business related and eligible for a deduction.”
5. Furniture and vehicles
The purchase of office furniture offers a couple choices: You can deduct 100 percent of the cost in the year of the purchase or deduct a portion of the expense over seven years, called depreciation.
To take the whole cost in one tax year, use the Section 179 deduction. Recent tax law changes have made this deduction even more attractive. For 2004, a business owner can expense up to $102,000 under Section 179. Prior to 2003, the amount was $25,000.
If you choose depreciation, you are not supposed to split the cost into equal portions over the depreciation period. Instead, use an IRS chart to make separate calculations each year. You can decide which is better by trying to anticipate the years that your business will need these deductions the most.
“The enhancements made to the Code Section 179 deduction will dramatically impact the limousine industry,” Fino says. “These enhancements enable an operator to expense in the year of acquisition the cost of qualifying property up to a threshold.”
In the past, if an owner purchased a limousine that cost $80,000, he was not able to fully expense the car in the year of acquisition because the cost of the car fell above the threshold of the Section 179 deduction, Fino says. Operators would have to expense the car up to the threshold and depreciate the remainder of the cost of the vehicle over its useful life.
Today, the entire cost of an $80,000 limousine can be deducted in the same year. However, these enhancements are due to expire for tax years beginning in 2008, so a proper plan should be established to detail intended equipment acquisitions over the next few years.
6. Other equipment
Computers, copiers, fax machines, scanners and other equipment used in your business are also tax deductible. As with furniture, you can take 100 percent up front or depreciate. With equipment, the depreciation period can be over five years.
7. Software and subscriptions
Section 179 also recently increased the tax break in this area. Previously, a company had to depreciate the cost of computer software over three years. Now, off-the-shelf software purchased expressly for business can be fully expensed in the year it was purchased.
These deductions are allowed for tax years 2004-2008. Business and industry-related magazine subscriptions, such as LCT, may also be deducted. You can take the total cost as a full deduction in the year you made the purchase.
You can get money back if you drive on business, but the IRS will want documentation. To be extra safe, keep a notebook in your vehicle to record the date, mileage, tolls, parking costs and purpose of the trip. This is not for chauffeurs, but for people who must travel to attend meetings, make purchases, visit clients, etc.
At year end, you have two choices: You can total the mileage, multiply it by 37.5 cents per mile for your 2004 tax computations, and add in tolls and parking to calculate your deduction. Or you can measure your business usage against your personal driving and deduct that portion of your auto-related expenses. Remember to include gas, repairs and insurance.
Lease payments should be included. For a car that is purchased, factor in the interest on the loan and depreciation on the vehicle.
If you have a home office, you can deduct the entire business-related mileage, from the time you pull out of the driveway until you return home. If your business is not home-based, your mileage meter starts at your first business-related destination and ends at your last. You are not allowed to include the drive to and from home.
To optimize your deduction, try to schedule multiple business appointments on the same day to allow you to take the mileage between stops as a tax write-off.
9. Retirement contributions
Be sure to deduct the contribution you make to your own retirement fund with an SEP-IRA or Keogh on your personal income tax return if you are self-employed.
“The majority of clients I talk to who do not have a retirement plan were unaware that they could take a deduction in the current year, even though they will not put the money into the plan until the next year,” Fino states. “This is advantageous, especially if cash flow is tight at year-end and you want to maximize your investment in your retirement account.”
Another advantage of funding a retirement account is the immediate tax advantage. If a taxpayer has a marginal combined tax rate of 40 percent for federal and state, funding a retirement plan with $10,000 would save him $4,000 in taxes in the current year.
“Every year I invest in a ROTH IRA,” Woodruff says. “Though it doesn’t offer a deduction, the money you withdraw later is not taxed. You just watch it grow and you don’t have to pay taxes on the gain.”
10. Social Security
A little bad news: If you’re self-employed or starting a small business, you must pay double the Social Security contributions you would as an employee, since federal law requires employers to pay half while employees pay the other half. Self-employed workers are both.
The total will equal 15.3 percent of your net profits. Deduct half of the contribution on your 1040.
11. Telephone charges
The cost of business calls made from home can be deducted. On your bill, circle the business-related calls, total them up and keep a copy. At the end of the year, tally the bills and deduct 100 percent.
The IRS assumes you will have a phone in your house, so you cannot deduct the regular fees and charges of having a phone. However, if you have a second line installed and use it only for business, all of its charges are deductible.
12. Child labor
As it turns out, it can be a good idea to have your kids wash your vehicles or help around the office. If you pay them less than $4,750 a year, they will probably avoid any additional taxes. Plus, there is no Social Security tax when you hire a child 17 years or younger. You can actually deduct this as a business expense.
This break is only available if you operate as a sole proprietor or as a partnership in which you and your spouse are the only partners. If your business runs as a corporation, then it, not you, is considered the employer and the corporation is not relieved of the tax liabilities. Your money can go even further if your child contributes to a Roth IRA. You get a nice tax deduction on the salary and you teach your youngster to save.