May, 2004 Tax Newsletter

Overlook Business Deductions – Overpay Your Tax

Unless you filed an extension for your 2003 tax return, your return has now been prepared and filed and perhaps you are still agonizing over the income and self-employment taxes you had to pay on your business profit.  This month’s newsletter revisits (with appropriate modifications) the March, 2003 newsletter relating to business deductions often overlooked .  If you find that you were entitled to some of these but did not avail yourself of them, you can file an amended return.  If your return is on extension, by all means take them into consideration when it is prepared.

1. Auto expenses – While operating a car is getting more expensive almost daily, the good news is that if you use your car for business, or your business owns its own vehicle, you can deduct some of the costs of operating it.   There are two approved methods of claiming these expenses: you can either keep track and deduct your actual business related expenses, or you deduct 36 cents (2003); 37½ cents (2004) for each business mile driven.  As a rule, if you use a newer car primarily for business, the actual expense method provides a larger deduction, while if you drive an older car (and possibly newer car as well) a substantial number of business miles, the mileage alternative might be better.  If your auto is used for both business and pleasure, only the business portion is deductible. That means you must keep track of how the vehicle is used and be able to establish total and business miles driven.  This is critical in the event of an audit.

2. Expenses of going Into business - Once you are running a business, expenses such as advertising, utilities, office supplies, and repairs can be deducted as business expenses. But expenses incurred before you open your doors for business are not deductible. The costs of getting a business started are capital expenses, which must be deducted over the first 5 years you are in business (but only if you make the proper election).  TIP: There is a strategy I use to help my clients protect their ability to write off "start-up" costs over 5 years in the event this issue is audited.

3. Education expenses - You can deduct education expenses if they are related to your current business, trade, or occupation, but you must follow strict rules. The expense must be to maintain or improve skills required in your present employment or be required by your employer, or be a legal requirement of your job. The cost of education that qualifies you for a new job isn't deductible.

4. Legal and professional fees - Fees you pay lawyers, tax professionals, or consultants generally can be deducted in the year incurred. But if the work relates to future years, they must be deducted over the life of the benefit.   The best suggestion I can offer  is to get a properly itemized bill from the service provider setting forth the services that were performed and the amount billed for each.

5. Bad debts - If a client or customer doesn't pay you, the bad debt may or may not be deductible depending upon the kind of product your business sells and your method of accounting.  If your business sells goods, you can deduct the cost of goods that you sell if you don't get paid.   If, however, your business provides services, no deduction is allowed for the time you devoted to the client or customer who doesn't pay.  Presumably the rationale for this is that businesses might inflate bills and claim large deductions for bad debts.

6. Business meals and entertainment - If you entertain present or prospective customers, you may deduct 50% of the cost if it is either "directly related" to the business, and business is discussed - for example, a catered meeting at your office; or "associated with" the business where the entertainment takes place immediately before or after a business discussion.  TIP: On the receipt (required if over $75) always make a note of who, what, where, when and why with regard to the meal or entertainment.  Note that while a receipt is not required if the item is less than $75, there must still be documentation of the expense in your records.

7. Travel - When you travel for business, you can deduct many expenses, including the cost of plane fare, costs of operating a car, taxis, lodging, meals (at 50%), shipping business materials, clothes cleaning, telephone calls, faxes and tips.  Combining business and pleasure is permissible as long as business is the primary purpose of the trip.  However, if you take your family along, you can deduct only your expenses, just as if you had traveled alone.

8.  Home office - To qualify for a home office deduction, you must use your home office on both an exclusive and regular basis as your principal place of business or as a place of business to meet with clients. If you qualify, you may deduct depreciation allocated to your business use of the area in your home and other indirect expenses of operating your home office. You also may claim this deduction if your home office is the only place for conducting the administrative or management activities of your business or if only minimal administrative work is done outside your home office

9.  Interest - If you use credit to finance business purchases, interest and carrying charges are fully tax deductible. The same is true if you take out a personal loan and use the proceeds for your business. But be sure to keep good records showing that the money was really put into your business. Otherwise, if you're audited, the interest expense deduction could be disallowed if it's considered a personal expense .

10.  Expensing deduction - For tax years beginning in 2003, 2004, and 2005, small business owners can elect to immediately deduct 100 percent of the cost of qualified business property up to $100,000 $100,000 (2003 amount); $102,000 (2004 amount) instead of depreciating it over several years. Keep in mind that this "Section 179" allowance is phased out on a dollar-for-dollar basis when qualifying assets costing over $400,000 are placed in service in any one of the years

11. Software - As a general rule, software bought for business use must be depreciated over a 36-month period. But there are three important exceptions:  (1) Software with a useful life of less than a year (and given the rapid change in technology, this could apply to a lot of programs) can be deducted as a business expense in the year you buy it, (2) If the software comes with a computer, and its cost is not separately stated, it's treated as part of the hardware and is depreciated over 5 years, and (3) You can write off a whole computer system, including bundled software, in the first year under Section 179, subject to the limits mentioned in item 10.

12.  Health insurance premiums - Self-employed individuals can now deduct as an adjustment to gross income 100 percent of health insurance premiums.

13.  Retirement plan contributions - Putting funds in a retirement plan such as a Keogh or a SEP plan reduces your taxable income and helps to ensure a secure retirement. If you've already set up a Keogh retirement plan in 2003 or prior years, to qualify for a deduction in 2003 you must make your contribution at any time up to the due date of your return, including any extensions. If you missed the deadline for setting up a Keogh plan, consider a simplified employee pension (SEP) plan. You have until April 15 or the date you file your return with a proper extension to set up and make a deductible contribution to a SEP.

14. Charitable contributions - If your business is a partnership, limited liability company, or S corporation (a corporation that has chosen to be taxed like a partnership), your business can make a charitable contribution and pass the deduction through to the owners to claim on their individual tax returns. If you own a regular (C) corporation, the corporation can (subject to limitations) deduct the charitable contributions.  TIP: If you've got some old computers or office furniture, consider giving it to a school or other nonprofit organization. This can yield goodwill plus a tax benefit. But if the equipment has been fully depreciated (written off) you can't claim a deduction.

15. Taxes - Taxes incurred in operating your business are generally deductible.  How and when they are deducted depends on the type of tax.

Sales tax on items you buy for your business in day-to-day operations is deductible as part of the cost of the items; it's not deducted separately. But tax on a big business asset, such as a car, must be added to the car's cost basis; it isn't all deductible in the year the car was bought.

If your business pays employment taxes, the employer's share is deductible as a business expense. Self-employment tax is paid by individuals, not their businesses, and so is not a business expense.

Federal income tax paid on business income is never deductible. State income tax paid by a corporation can be deducted on the corporation's federal return.  State income tax paid by an individual, even if it results from a business, must be taken as an itemized deduction, not as a business expense.

Real estate tax on property used for business is deductible, along with any special local assessments for repairs or maintenance. If the assessment is for an improvement - for example to build a sidewalk - it isn't immediately deductible; instead it is deducted over a period of years.

16. Advertising and promotion - The cost of ordinary advertising of your goods or services, such as business cards, yellow-page ads, etc. is deductible as a current expense.  Promotional costs, such as  sponsoring a youth football team are also deductible as long as there is a clear connection between the sponsorship and your business.  For example, naming the team "Southwest Auto Parts Blues" or listing the business name in the program is evidence of the promotion effort.

Here are some additional routine deductions that many business owners miss.

* audio and videotapes related to business skills

* bank service charges

* business association dues

* business gifts (limited to $25 per person)

* business related magazines and books

* casual labor and tips

* casualty and theft losses

* coffee and beverage service

* commissions

* consultant fees

* credit bureau fees

* office supplies

* online computer services related to business

* parking and meters

* petty cash funds

* postage

* promotion and publicity

* seminars and trade shows

* taxi and bus fare

* telephone calls away from the business

Here's hoping you avail yourself of ALL the deductions that apply to your business.  If you have any questions, I'd be happy to discuss them with you.