Archive for Business Tax Deductions

Home Office Tax Deduction

How and when to take the home office deduction on your taxes can be confusing, but if you meet the criteria, it’s a legitimate deduction so don’t just discard the idea. There has always been scuttlebutt that using the deduction raises your risk of audit. Not true, according to the IRS. So what do you do?

Since there is no way to know for sure, having good documentation is the best way to protect your home office deduction in case it’s questioned. You need to show that you are using the home office “exclusively and regularly” for managing your business and performing administrative tasks.

Proving Home Office Use

The type of documentation that supports this deduction includes:

  • Tracking the home overhead expenses involved, such as rent, mortgage, utilities, etc.
  • Saving receipts for any specific alterations you make to create the home office space
  •  Having a floor plan showing the actual area dedicated to the business, including any areas you use for storage of products or supplies
  • Contemporaneous records of time spent in the home office working vs. being out on sales calls or meetings

The last item is sometimes a bit trickier to document, but a good start is to keep activity notes. If you’re in your home office making calls, meeting with your bookkeeper, ordering materials or doing other administrative tasks, it’s easy enough to note that activity in your calendar at the end of the day.  That way it’s documented the same way that your out of office business activities are.

An accountant can answer specifics about your situation and tax software will help walk you through the calculations if you prepare your own taxes.  And detailed home office information is also available on the IRS website.

The good news is that the IRS may be making this calculation easier in 2013. We’ll keep you posted if they do.


Small Business or Hobby?

net profit tax formIt’s quite possible that you and the IRS might disagree on this question, so keep good records to substantiate your position that what you are doing is actually a business.

If you’re a sole proprietor reporting your business on Schedule C of your personal tax return, the question of whether or not you are actually running a business is the basis for your ability to deduct business losses against other income like wages. Whether an activity is a hobby or a business is sometimes difficult to discern, especially for businesses with relatively low revenues in professions that are also often engaged in as a leisure activity, e.g. jewelry making or crafts.

If you’ve deducted losses in prior years & the IRS reclassifies your business as a hobby you can be subject to back taxes and interest, not to mention the prospect of being audited for up to 3 years of tax returns. Generally, the IRS expects you to report a profit in at least 3 of the last 5 years for you to be considered a business. But considering the economy in the last few years, making a profit has been difficult or impossible for businesses of all sizes, not just sole proprietorships.

The 3 years out of 5 profit rule isn’t an absolute, but it may take explaining and could flag you for an audit. If you are truly running a business, be prepared to prove it. Remember, with the tax authorities, the onus is on the taxpayer to provide sufficient documentation.

Start with keeping accurate books for the business, with documentation for all sales and expenses. Operate as a true business: use a separate bank account, don’t mix personal and business deductions, get a business license if it’s required, stay in compliance with all local laws and filings around sales tax, do professional development to improve your skills, have a plan about how you intend to grow your business, and keep records of marketing and networking efforts you make.

In short, if it isn’t a hobby, don’t approach it like a hobby. Chances are these steps will also help you to actually build your business so that you can start reporting a profit on a regular basis, in which case the 3 years out of 5 concept won’t be an issue any longer.


The Business Will Pay for It

expense report photoWhat a loaded statement that is, but I’ve heard it a thousand times. “The business” isn’t some disembodied entity with limitless cash resources. If you’re a small business owner, the business is you.
So, you’re paying for it…whatever “it” is.
For most people, the translation of this phrase means that it’s a deductible business expense and so therefore the true cost is somehow discounted. But just because “the business will pay for it,” doesn’t mean it’s a good way to spend money…and it is your money if you own the business. This line of reasoning is particularly prevalent among small business owners who came out of corporate and had a business expense account. In that case, the business was paying for it. Now that you are the business, you’re paying for it and it is important to understand that distinction.
When choosing which business expenditures to make, evaluate them in light of their absolute cost and decide if it’s worth it or not.  Just because something is tax deductible doesn’t make it a smart business move. Some business owners push the envelope on this business expense issue, especially around entertainment expenses. Don’t get caught in the trap of “letting the business pay for it” if the expense is actually a personal one and it doesn’t have a legitimate business purpose. If you’re audited and the deductions are disallowed, you could be facing a hefty tax bill along with penalties or interest.