Don't Overpay Your Taxes: 5 Can't Miss Small-Business Deductions
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It’s tax time and whether they know it or not, small-business owners might be leaving hundreds, even thousands of dollars off the table.
“Numerous businesses overpay their taxes every year by overlooking various tax deductions,” says Michael Raanan, a former IRS revenue officer who is president of Santa Ana, Calif.-based Landmark Tax Group.
In some cases, entrepreneurs simply aren’t aware of the deductions available. In others, they don’t keep detailed records or shy away from itemizing or complicated number crunching, habits that can be costly in the long run.
To save you headaches, money and time, we’ve reached out to our tax experts for oft-missed deductions to discuss with your tax professional as the IRS’ April 15 tax filing deadline approaches.
Business-related meals and entertainment. Eric Levenhagen, tax strategist and CPA at ProWise Tax & Accounting in Mason City, Iowa, has found that costs for lunches, dinners and client-evenings out can easily run into the thousands of dollars, especially for heavily-networked business owners. Business owners often don’t deduct the expenses because they aren’t sure whether such meetings were business-related, and they don’t save the receipts. Says Levenhagen, such events must involve work, but there’s no hard and fast rule over what portion of the meeting needs to be taken up by business talk. So feel safe deducting it as long as you can show a new client lead or a service referral came from the meeting. “It has to be something substantial or something that has a potential to further your business,” Levenhagen said. Save the receipt (though a bank statement can work for meals or entertainment expenses under $75), and make a quick note of the business-related purpose on it, or in a day planner or calendar, so you have a record in case an auditor asks.
Crunching car expenses the hard way. Sure, a business owner can go the easy way and calculate business-related car costs using the IRS standard mileage rate, which was 56.5 cents per mile in the 2013 tax year. But in this case, the hard way can pay off. Levenhagen has seen clients save hundreds of extra dollars by dividing business-related miles by total miles driven and then applying the percentage not only to gasoline costs but all the actual expenses related to that vehicle, including car washes, tires changed -- even satellite radio fees. “Anything that is for the betterment of the vehicle.” As with meal and entertainment expenses, the day planner or the calendar becomes an important tax record. Remember that miles driven from home to the office and back are not business-related mileage. (Business owners who work from home but don’t claim a home office face a major disadvantage over mileage, because every trip out of the house is then a commute.)
Choosing the tougher path on the home office. This is the first tax-filing season in which the IRS is allowing a simplified home office deduction of $5 per square foot, with a limit of $1,500 for 300 square feet of home office space. But Gail Rosen, a Martinsville, N.J.-based CPA, suspects it is potentially possible for some to squeeze out thousands of extra dollars by using the traditional, more daunting method, which involves measuring the home office’s square footage, dividing it by the home’s total square footage, and then applying the percentage to a host of home-related expenses from mortgage interest to utility bills to home depreciation. So crunch the home office deduction using each method, and see which one has the most savings. Here’s one note of caution if going the traditional route: People claiming a portion of home depreciation could be stuck paying a “depreciation recapture” should they sell their homes for a profit down the road. Also make sure the home office really is a defined area where you regularly conduct work; a studio apartment or room where your kids also play video games won’t cut it.
Remembering startup costs. Rosen finds new business owners don’t often realize that the expenses that got their business off the ground can be deducted once the business starts. “They have expenses that they incurred beforehand that they missed out on keeping track of,” Rosen said. These might include a continuing education course, a lunch with a future client, or a previously-purchased computer that is now a home office workhorse. Rosen says there is really no limit when it comes to how far back the expense was incurred. As soon as the business starts logging sales, those expenses from can be counted as deductions: You can elect to deduct up to $5,000 for the first year, and the rest amortized over 15 years. (Note: If it is a computer or other previously-bought item drafted into business use, claim the present fair-market value.) The hitch is that there needs to be adequate records. Auto records don't need to be contemporaneous, but the IRS still recommends keeping a logbook in the car to ensure proper documentation. Credit card records might not cut it, because only a receipt can show the $600 charge at Best Buy was for a computer.
Don’t forget employee expenses. The reimbursements you provide your own employees are also deductible, Raanan said. That is especially true for expenses related to work such as gas, meals, hotel accommodations, tips, transportation and even baggage fees. To claim such a deduction, a business needs to have an “accountable plan” in which it can be shown that the reimbursed expenses were actually business-related. Employees must substantiate their expenses within 60 days and refund any excess advances within 120 days. “It is essential that business owners keep sufficient backup documentation [such as receipts] … in case the IRS comes calling,” Raanan said.
To take even greater advantage, Levenhagen suggests business owners think in the long term, working with a tax professional to figure out strategies that work not only now, but for where the business is going to be five years from now. A good tax professional can advise you on the best practices -- such as a system for saving receipts and recording deductible activities. “You’ve really got to sit down and crunch the numbers,” Levenhagen says. “Project it out four to five years.”