Opportunities abound for small businesses to cut their tax bills. The key is understanding what's deductible for your business.
A good tax preparer can guide you, but it is your responsibility to save receipts throughout the year.
"Organization and good record keeping are the keys to lower tax preparation fees and painless IRS audits," says Sam Fawaz, a certified financial planner and certified public accountant with Y.D. Financial Services in Franklin, Tenn. "Bringing a shoe box to your CPA or accountant and saying, 'Here are my tax records; please prepare my return' will undoubtedly cost you more in compilation and accounting fees to arrive at tax return numbers."
Here's a rundown of expenses to track in preparation for tax day.
- Auto expenses: You may deduct mileage, parking fees and tolls for business use of your car. Most people take the standard mileage rate deduction because the record keeping requirements are less burdensome, but actual expenses often yield a larger deduction, says Fawaz. Keep track of the mileage, odometer start and finish for each trip, destination, the starting point and business purpose. "The actual expense method often yields a higher deduction, including repairs, insurance, maintenance and depreciation for the business portion of use," Fawaz says.
- Equipment, furniture and supplies: Look at your purchases and ask your tax preparer to run the calculations to see if you should expense it or depreciate it. But don't overdo it, says Clare Wherley, a certified financial planner and certified public accountant with Lassus Wherley in New Providence, N.J. "I've often had to caution the entrepreneur that buying a piece of equipment just to get a tax deduction isn't good business sense."
- Professional and legal expenses, and association dues: Professional and legal expenses are deductible, but if the costs are part of startup expenses, you may need to amortize the cost over 60 months. Association dues may include a portion for political contributions or lobbying, so those can't be deducted, Fawaz says, noting the association must disclose this amount or percentage.
- Expenses to start up or expand your business: The biggest mistake in deducting expenses to start up or expand your business is failing to make an election to amortize or deduct these expenses in the first year. A paper election is required to be attached to the return, stating your intention to amortize them, Fawaz says. Otherwise, the expenses become nondeductible until you sell or liquidate the business.
- Professional publications and software: Here again, the common error is taking the cost as an expense instead of amortizing, Fawaz says. Software licensing fees, for example, should be capitalized and amortized over 60 months unless it has a life of only one year, such as an annual maintenance agreement. Professional publications should be amortized over the subscription period if prepaid.
- Gifts and advertising: Client gifts are deductible up to only $25 per gift. And if you advertise, deductions taken for costs that cover multiple-year contracts must be spread over all the contract years, Wherley says.
- Home office: If you have a legitimate home office, don't be afraid to deduct it. To qualify, the room must be used exclusively for business. It can't double as a spare bedroom or toy room for your kids. You can deduct a portion of rent, utilities, insurance, taxes, maintenance, professional cleaning, depreciation and interest. State tax deductions will vary.
- Telephone and internet: Any dedicated services for your business are deductible. If you use your home or personal cell phone for business, you may only deduct the portion used for business purposes.
- Education and training: You may deduct the cost of continuing education or certification for the business you're already in, but education that qualifies you for a new line of business is not deductible, Fawaz says.
- Bad debts: A bad debt is only deductible if the income has been declared. Wherley offers this example: A business owner bills a client in December 2009 and declares that income on his 2009 return. By the end of 2010, he realizes he will not be paid by that client. So in 2010, he can take a bad debt deduction for the income previously declared. If that income was not declared, he can't take the bad debt deduction.
- Interest on loans: You can fully deduct interest on loans for your business. If you have a loan from a relative, make sure it conforms to IRS rules.
- Entertainment and travel expenses: Keep excellent records here, and keep a log of who you met, why, where, when and for what business purpose. "Only 50 percent of meals and entertainment costs is deductible, and none of the costs associated with country club memberships are deductible," Wherley says.
- Taxes and Social Security: State taxes paid are a healthy deduction; just don't allow yourself to be surprised by how high Uncle Sam's bill may be. "I often advise setting aside 50 percent of net income to cover everything," Wherley says. "If there is something left over, the refund is that much sweeter."
- Insurance: Insurance premiums for the business for one year or less are deductible currently, while excess prepaid premiums are deductible in subsequent years, Fawaz says.
- Charity: Save all your receipts, and don't forget to keep track of contributions of inventory or property.