Tax-Planning Expert Sandy Botkin

Hire your children, write off your golf game and other legal tax deductions that you might not know about

By Laura Tiffany

Opinions expressed by Entrepreneur contributors are their own.

So you think the government is out to rob you of all yourhard-earned money? Every time you hear the word "tax,"you recoil in fear? Cheer up! It's not that bad--especially ifyou're a business owner.

Tax expert Sandy Botkin, author of Lower Your Taxes Big Time! and a formerIRS attorney, says there is hope for all us saps who just hand overour paychecks to Uncle Sam. Read on for Botkin's tips on takingadvantage of tons of business tax deductions--all within the letterof the law.

You say that homebased business is one of the few legal taxshelters left. What does that mean?
Sandy Botkin: First of all, understand something: We havetwo tax systems in this country. [Many] times people thinkthere's one for rich and one for poor. That is a huge myth.What the systems are is one for employees--people who don'tknow the rules, which are designed to take your wealth--and one forself-employed people, [the rules of] which are designed to createeconomic growth. The reason for that is, small business generatesover 70 percent of the jobs in this country. So Congress passesgood tax laws. And there are good tax laws--let me emphasizethis--for small business.

Let's say your business generates a loss. If that lossexceeds the income from that business, you can use that lossagainst any form of income you have: interest, dividends, rents,wages, pensions, anything. Say you make $50,000 in salary and youhave a small business that creates a $10,000 loss. You only pay taxon $40,000. Let's say the loss exceeds your whole income. Youcan carry back all business losses in 2002 five years and actuallyget a refund from the last five years' federal and state incometax you paid. In 2003, by the way, that number is going down to twoyears. Or you can carry forward all business losses 20 years andoffset the next 20 years of earning. So you never lose a properlydocumented business deduction.

What if your homebased business is profitable? How can youstill save on your taxes?
Botkin: By having a profitable homebased business, you canset up a host of fringe benefits, many of which I include in mybook. You can set up a self-insured medical reimbursement plan andwrite off all your deductibles, eyeglasses, co-insurance,pre-existing conditions. Usually that stuff has to exceed a certainthreshold [7.5 percent of your adjusted gross income] to deductanything. With a self-insured medical reimbursement plan, you get adeduction regardless. It's dollar for dollar.

What other deductions do people not typically knowabout?
Botkin: As an employee, you have to pay [taxes oneverything]. As a self-employed person, you don't pay tax untilall your deductions are over. So [if you're an employee making]$60,000 a year, you've got to pay Social Security on 15.3percent of $60,000. You've got to pay income tax on $60,000,regardless of your employee business expenses. [But] if you'reself-employed--let's say you have $40,000 of expenses on that$60,000, you only pay tax on $20,000. You pay tax on your net. Seethe difference?

So what are some things you can do? If you have a child and youwant to send them to college, that isn't deductible. And if youpay for their wedding, is that deductible? The answer is no. But ifyou were to hire your children in your business and pay them [thesame] wage you'd pay an assistant, that's deductible. Andif they use that money to pay for their own college or their ownwedding or their own car, aren't you in essence getting adeduction for those things?

And by the way, children under 18--if you hire them in a soleproprietorship business--are exempt from Social Security andfederal unemployment taxes, and the first $4,700 they made in 2002is exempt from income tax. Result? You get a deduction, and theyget that money tax-free.

So to protect yourself, you need to do the same paperwork asyou would a normal employee?
Botkin: Good point. You want to have things like time sheetsor a tax diary showing what your kid did. So for example, you mightsay Matthew, my son, sorted files and made 3-by-5 cards for fourhours on February 3. That shows what he did, when he did it and howlong he worked.

You also want to pay by check--none of this under-the-tablenonsense, because [checks] establish a payment from you to yourchild to your child's bank account. You want to have theappropriate paperwork done. There are W-2s you have to file once ayear and 940s and 941s for unemployment and Social Security. But Irecommend using a payroll service, because people don't want todo all this paperwork. They will do all the payroll, all the forms,all the filings. You also want to have a contract for servicesshowing you hired your kids and what you're paying them, anormal contract like any other employee.

Does all this apply when you hire your spouse aswell?
Botkin: Yes, it's all the same. Now for hiring yourspouse, you can set up a self-insured medical reimbursement plan. Ican deduct all my medical expenses, dollar for dollar--not becauseI'm paying medical, but because I'm providing a medicalreimbursement plan for my employee, who I happen to be married to.And the IRS has approved this, by the way. It's not someloophole I thought up.

What are some other techniques for takingdeductions?
Botkin: A lot of people don't know that when you'rein business, you can deduct your fun. IRS says in their regulationsthat you can deduct 50 percent of your fun and 50 percent of your[business associate's] fun if you talk business within the same24-hour day as the fun. Say you invite a prospect over to go to afootball game. You talk business over the phone and then pick themup two hours later. Is that talking business within the same24-hour day? The answer is yes. Say we go to a restaurant and Italk to you in the car about our business or try to get referralsand then we go to a nice theater. Is that talking business withinthe same 24-hour day? The answer is yes.

You also don't need receipts for entertainment if it'sunder $75 per expense. Now when you do entertain, the IRS requirescertain documentation. So with entertainment, you have to writedown what I call the four Ws and an H:

  • Who: name and occupation
  • Where: We went to Greasy Lloyd's restaurant.
  • Why: Why did you take that person out?

And here's one of the biggest mistakes self-employed peoplemake. You must be specific in the documentation. The word"prospect" isn't specific enough. "Goodwill" isn't specific enough. Specific would be "tryto get a referral" or "talked with a reporter about mybook." Don't be general.

  • What: What was the date, and was it for breakfast, lunch ordinner?
  • And finally, how much.

If you write down all five things, you'll never have toworry about an IRS audit again. If you leave out any one of thefive, your deductions will be disallowed and the IRS will hit youwith a 75 percent penalty, plus interest.

Why is it so important to make yourself aware of thesethings?
Botkin: What amazes me is, say you look at your credit cardstatement and there's a $200 charge you never saw before.Aren't you going to call the credit card company and find outwhat's going on? And you might spend an hour on the phone doingthat. Yet taxes are the number-one expense in this country. Theyexceed what most people pay for food, clothing, lodging andtransportation combined. [But] 99 [percent of people] give it a10-minute thought. And the reason is, there's a huge myth inthis country. "My accountant takes care of my taxes."

What are some audit red flags that people need toavoid?
Botkin: The number-one red flag is failing to report allyour income. The IRS matches all those 1099s you get from your bankaccounts, your stock brokerage companies, whatever. If there'sa mismatch--suppose you made $30,000, but you only report$28,000--then you're calling attention to your tax return.

The second thing you want to do is do not use cents in figuringout your tax return. Always round. Mathematical errors cause someof the biggest scrutiny of your tax return because things don'tmatch up. If you use cents, you're just increasing your chanceof making an error.

If you do your own tax return, for the most part, you increaseyour chance of being selected for an audit. The IRS figures if youdo your own return, you don't know what you're doing,unlike accountants who might do hundreds of returns. People tend tomake more mathematical mistakes when they do their own returns thanaccountants make.

Third major tip to reducing your chance of audit: Always, alwayssend in your tax return with a return receipt. And if there's acheck, send it registered mail or FedEx. There [have even been]cases where if you do send it FedEx [and it is lost], the IRS willwaive penalties.

I'll give you another nice tip. Many times people call theIRS for information, especially during this time of year. Theproblem is, the IRS isn't bound to anything they tell you.However, there is one situation where you can call IRS and if youget a bad answer, they'll waive penalties. But you've gotto get six things when you call them: The person's name, theirbadge number, the date of the call, the time of the call, thenature of the question and the answer. If you write down all sixthings and you get a bad answer that IRS relied on, they'llwaive penalties.

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