One of the big advantages of owning a business is that many of the costs of doing business are tax deductible. Your CPA can help you figure out exactly which costs fall into this category, but here a few general guidelines:
General and Administrative Expenses
Deductible general and administrative (G&A) expenses include telephone, utilities, office rent, salaries, legal and accounting expenses, professional services, dues, and subscriptions to business publications.
If you work out of your home, investigate whether a home-office deduction makes sense for you. Remember that you can only claim this deduction if your home office is your principal place of business and that office is used for no other purposes other than your business. If you have another office somewhere else, you may not be able to deduct the cost of a home office as well. You can deduct business-related telephone charges made from your home number, as well as business equipment and supplies, but you will not be able to deduct any part of your rent or depreciate any part of the property as a business expense.
Home-office expenses that are eligible for deduction include all normal office expenses plus interest, taxes, insurance, and depreciation on the portion of your home used exclusively for business. Allocation of home-office expenses is generally made on the basis of the ratio of square footage used exclusively for business to total square footage of the residence.
If the business didn't make enough money to absorb the home-office deduction, you can deduct the excess from income earned on a 9-to-5 job, if you still have one, or from your spouse's income, if you file a joint return. However, there is a limit to what you may deduct. All your home-office expenses are deductible if they are less than your gross income from the business use of your home. If they're greater, you can carry them over to the following year.
As of January 1, 2006, business-related automobile mileage is deductible at the rate of 44.5 cents a mile. To calculate the deductions you could make based on straight mileage is very simple. Suppose you drive a car 20,000 miles a year. Of those, 12,000 were for business purposes. Your deduction would be 44.5 cents x 12,000 miles, or $5,340.
What constitutes a business mile? The distance you drive from your home to your place of business is not deductible, but mileage you drive from your place of business to any other location for business purposes is. Meeting with a prospective client or doing something to promote your business is considered business mileage. Just make sure to keep a log of your business-related travel for tax purposes; at the end of each day enter the miles you drove on your appointment calendar.
There's another method for deducting the cost of driving using actual operating expenses. Typical deductions include gasoline, maintenance, insurance, and depreciation. For example, assume that your depreciation deduction is $2,800. Add to this the following expenses for operating your car: insurance, $400; maintenance, $500; gasoline, $1,600. You have $5,300 in deductions. Take this number and multiply it by the fraction of business miles over total miles driven: 12,000 business miles divided by 20,000 total miles, or 60 percent business mileage. Sixty percent of $5,300 is $3,180. If you elect the second method, then, you get a deduction of $3,180 for the same mileage versus the $5,340 for straight-mileage calculation.
If you use this second method, you must stick with it for the life of the car you use for business. If you sell the car for a profit, you have to take the depreciation off its cost to determine its tax basis. If you sell it for more than its base, you'll have a gain that's taxable at your regular income tax rate.
Generally, straight mileage is best if you're driving an older car many miles. If you're driving a fairly new car with a fairly high cost, the operating expenses/depreciation method might result in higher deductions. Ask your CPA to help you figure out which method makes most sense for you.
Entertainment and Travel
If you entertain clients to promote your business, maintain a log for deductible entertainment, travel, and related expenses. Use a standard appointment calendar to write in whom you were entertaining, the nature of the business, where you were, and how much you spent. Contrary to popular belief, you do not need receipts for entertainment expenditures under $75, but you must maintain a log. In certain instances you can even claim business-related entertainment at home-as a precaution, have clients or prospects sign a guest log. If you prepare a meal or serve drinks, your expenses are deductible as part of the cost of doing business.
Currently, only 50 percent of entertainment expenses are deductible. The remaining 50 percent are not deductible, even if your business is incorporated. For entertainment expenses, these five elements must be recorded:
1. The amount of expenditure;
2. The date of expenditure;
3. The location and type of entertainment;
4. The reason for entertainment and the nature of the business discussion that took place;
5. The occupation of the person being entertained.
A deduction is not permitted for travel, food, and lodging expenses incurred in connection with attending a conference, convention, or seminar related to investment activities such as real estate investment or stock investments. However, the cost of the actual seminar is still deductible.
Travel deductions include the cost of air, bus, and auto transportation; hotels; meals; and incidentals including dry cleaning, tips, and taxis. However, you must stay overnight to claim travel-incidentals deductions.
Things you do to increase your expertise in your field of business are tax deductible. While deductions are allowed for convention expenses, rules limit the amount that can be deducted for attending conventions in foreign countries. Also, there are limits on the deductibility of conventions held on cruise ships. The cost of getting to and from the convention and the cost of your stay are deductible, but if you stay three days after the convention ends, those expenses are not deductible. Deductions for your spouse are not allowed unless he or she is active in the business.