Deductions. Say it with me; deductions. Now keep saying it and don’t stop. Starting at this time of year, this word should be the mantra of every smart small business owner that wants to keep a little more money in their pocket come tax time. I know, I know, it’s not even March. It seems way too early to even be talking about taxes. But, you might be surprised to know that the IRS starts accepting tax returns from Americans as early as January 31st. Even if you’re not an eager beaver and don’t intend to file your taxes for a while yet, possible tax deductions are something you need to start thinking about sooner rather than later.
If you have a business accountant – highly recommended – they can steer you in the direction of profitable write-offs, but you are ultimately responsible for taking the time and care to put together the proper documentation. Getting all of your records organized before you head to your accountant’s office can save both of you time and money. If you don’t have or can’t afford an accountant right now, you’ll want to make sure that you’re taking full advantage of the breaks being offered while staying on the right side of the law. The only thing worse than not taking advantage of a tax deduction is claiming one improperly and bringing the full scrutiny of the IRS down around your head.
So, to help you keep the most of your hard-earned money and avoid possible legal trouble, here is a list of where to find the juicy deductions you might miss, what you need to claim them, and how to avoid the most common pitfalls.
Warning: The key to making the most of small business deductions while staying on the right side of the law lies primarily in good financial hygiene. Business and personal finances should stay completely separate; this means separate bank accounts, separate debit cards, separate credit cards. This goes double for people who are self-employed and work from home. For those who have been practicing good financial hygiene, well done. For those who have let business and personal finances bleed together, do yourself a favour and separate them as soon as you can.
Deduct Your Start-Up Costs
Starting a business can be expensive; there are big ticket items to buy: furniture, machinery, and software. You may have to conduct surveys, consult experts, or train employees. Securing distributors or partners might mean a lot of travel. These costs, up to $50,000, can all be claimed as start-up costs. Small businesses can claim $5,000 of their start-up costs right off the bat in the first year of operation. They can claim an additional $5,000 for organizational costs associated with establishing their business if it’s a partnership. The rest of your start-up costs, minus the amount you deducted, can be amortized, or spread out, and deducted in equal amounts over a period of 15 years.
Warning: All start-up costs you want to claim must have been incurred before your business officially started operating. Check the dates on all of your receipts, invoices or pay stubs against your start date to make sure they’re valid for claim. Start-up costs do not include deductible interest, taxes, or R&D. Your start-up deduction must be claimed in the same year you opened for business. If you forget to claim your start-up costs, you have six months after filing your taxes to file an amendment. After that, you’re out of luck.
Tip: If you expect to start making large amounts of money right away, it may be in your interest to put off making some purchases or paying some bills until you’ve officially started business. This way you can write off your purchase as a capital expense in your first year and offset your profits more substantially. Alternatively, if you don’t want to delay paying bills, you can start doing a nominal amount of business at an earlier date, and expand your business later when you’re ready.
Deduct Your Home-Office
The home office deduction has traditionally been both one of the best and worst for the self-employed. Using this deduction, occasional or full-time work-from-homers are free to list a portion of their rent, phone, internet, mortgage interest, utilities, maintenance, real estate taxes, property insurance and depreciation as business expenses. The deduction is a tricky one because it requires the filer to prove that the space they’re claiming is being used exclusively for your job. Your work area doesn’t need to be physically separate from the rest of your home, but it must be specifically dedicated to work and regularly used.
Once you’ve established how much work space you use, figure out what percentage of your entire home that space constitutes. That’s the percentage of your other expenses you can deduct. For a helpful step-by-step, the IRS has a worksheet available. They even released an optional simplified claiming method this year.
Warning: This deduction, while one of the best for the self-employed, is also traditionally one of the more abused. Make sure that your calculations are correct, and that you don’t try to claim any space used both for business and personal purposes. If possible, when setting up your workspace for home, have the company buy the supplies. To claim this deduction you may need to go back and get copies of all of your utility bills. Having more rather than less documentation is a good idea. Keep all your receipts. You may be asked to justify this deduction.
Deduct Your Debt
The interest you pay on credit card purchases or loans for your business can now work in your favour and be used as deductions come tax time. As a small business you also get to deduct any service fees and late charges. So, dig out your credit card and bank statements, you’ll need them in order to be accurate and as proof.
Warning: This deduction highlights the importance of financial hygiene. Having separate credit cards and bank accounts can mean the difference between being able to claim a deduction or not. In the case of loan interest, you may be asked to prove that the entire balance of the loan was used for business purposes. Credit card purchases must be exclusively business related. If you don’t have separate card, make sure to label all credit card receipts with an explanation of what was bought. Try not to make personal and business purchases in the same transaction.
Deduct Your Travel
Your job may require that you travel. Luckily, a lot of the expenses attached to business related travel can be deducted. On a day-to-day basis, if driving to appointments or clients is required, you can deduct a portion of your car expenses – gas, maintenance, etc. For rare expenditures such as business trips or conferences, you can make deductions for plane tickets, accommodations, taxis and destination expenses, such as food.
Warning: Like the home office deduction, travel deductions have a history of being abused. This is not a deduction for which you should guess or fudge the numbers. For automobiles, how much you can claim is dependent on whether the car is exclusively for work or for both work and personal use. The rules surrounding travel write-offs for trips require that you prove that a certain percentage of your time was spent on business – percentages that change depending on the destination and length of stay.
The key to not getting burned on your deductions is diligent record keeping. For automobile deductions, keep detailed records of your mileage. For travel expenses, save all receipts and any documents that can be used to prove you were working. If the receipts are not itemized, make notes on them to remind yourself of exactly what was purchased. When in doubt, double check the worksheets on the IRS web page.
Deduct Your Professional Fees
Consulting experts and engaging professional help can be a drain on a small business’ budget. In acknowledgement of this, the government allows businesses to deduct money spent hiring professionals, such as lawyers and accountants, at the end of the year. If hiring a professional is financially unrealistic, you can also deduct any money spent on books, classes, or supplies that would help you execute the tasks a professional would perform.
Warning: Though you can deduct professional fees, you may not be able to deduct the full amount in one year. For situations where the professional has been engaged for a period of multiple years, the fees must be deducted equally over the same time period.
Deduct Your Schmoozing
Sometimes wining and dining a client is necessary, and the IRS knows it. You can deduct 50% of the cost of entertaining clients, so long as business take place during, or immediately before or after the event. That means taking a client to dinner or impressing them with a show can be partially written off so long as you can justify its importance to your business.
If the expense you’d like to deduct is open to the public at large – e.g. a community barbeque – then the 50% deduction limit no longer applies.
Warning: Things like restaurant receipts and tickets to a concert are going to raise the eyebrows of anyone looking over your return. Make sure to make note somewhere, on the receipt or in a ledger, of the specific business matter that was being discussed before or during what you’re trying to write off. It’s hard to remember what was spoken about months after the fact, and vague answers could get you into trouble.