TAXES & ACCOUNTING • March 9, 2016
3 minutes Read
For many small businesses, tax season is one of the most stressful times of the year. It often seems that many business owners are so afraid of making a mistake that will raise red flags at the IRS that they end up cheating themselves.
While you don’t want to short Uncle Sam, neither do you want to cheat yourself out of legal deductions. Below are just a few options for tax write-offs that every small business owner should know about.
Home office deductions
Small business owners and self-employed individuals are often hesitant to take a home office deduction, having long been told that claiming this deduction is a huge red flag for the IRS and a magnet for an audit. But the consensus among tax experts seems to be that there’s nothing to fear as long as your definition of “home office” concurs with that of the IRS.
According to the IRS, a home office must be a space devoted solely to your business and nothing else. That said, the deduction is not limited to a full room, so even if you don’t have an entire room devoted solely to your business, you can deduct part of the room that houses your business equipment. Simply measure your work area, and then divide by the square footage of your home. The resulting percentage is the fraction of your home-related expenses (mortgage or rent, utilities, or insurance) that you can claim. Just remember that the burden of proof is still on you, so even though a home office deduction isn’t necessarily a red flag, you will want to be extra careful that you are in compliance with the IRS’s definition of a home office. For much more information, go straight to the source and see what the IRS has to say about the matter.
If this is your first year of operation, don’t overlook this potential deduction which, according to some small business experts, is one of the most frequently missed deductions. Some of the costs you incurred before you officially opened your doors for business – including, in many cases, your expenses to research and explore business opportunities – may entitle you to a deduction.
In your first year of business, you can deduct up to $5,000 of the startup costs you incurred before you began operations, and if the costs exceed $5,000, they can be amortized ratably over a period of 15 years. If the costs exceed $50,000 there are certain limitations that apply. Be sure to check the information from the IRS. See Publication 535, particularly Chapter 8.
This is another frequently overlooked deductible. Granted, inventory items are not always immediately deductible; in fact, they’re usually treated as part of cost of goods sold. However, under a special rule, certain types of small businesses can use the cash method of accounting and can choose to treat inventory items as materials and supplies, which are currently deductible. As is the case with home offices, though, you need to be aware of the IRS’s definition of what constitutes a small business. According to the IRS, a small business is one with annual average gross receipts not exceeding $10 million for the three prior years – or the years in business if less than three years. As well, certain industries are excluded, so be sure your business qualifies. As a rule of thumb, eligible small businesses are service-based but maintain inventory; examples would include spas or beauty salons that provide services such as facials or hairstyling, but also sell beauty products and cosmetics.
In the event that you have been treating inventory as part of your cost of goods sold but decide you want to begin treating it as materials and supplies, you need to file for a change in accounting method on IRS Form 3115. Again, make sure you know the IRS’ rules before you attempt to take this deduction.
Office supplies, furniture and equipment
You may opt not to take the home-office deduction even if you have a home office, but you still might be able to deduct business supplies, some furniture, and other equipment. Of course you will want to hang on to your receipts.
You have a couple of different options for office furniture and for equipment such as computers, copiers, and scanners. You can either deduct 100 percent of the cost in the year that you purchase the item(s), or a portion of the expense over seven years for office furniture, and five years for other equipment. Deducting a portion of the expense annually is also known as depreciation. You have to be careful here because the IRS requires that you utilize their charts to make separate calculations each year. And as usual, various other restrictions and limitations apply.
It is up to you to decide which option is best for your business – the all-at-once deduction or depreciation. In both cases you will need to report it on IRS Form 4562.
And that was just for starters.
There are numerous other potential write-off options for small business owners, including mileage; software and subscriptions; telephone charges (including cell phones, if you use yours for your business); retirement contributions; travel, meals, entertainment and gifts; applicable insurance premiums – and even child labor, if you operate a sole proprietorship or a partnership in which you and your spouse are the only partners, and you hire your child who is 17 or younger. Again, it is important to always check with the IRS and/or your tax consultant when making tax decisions.
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IMPORTANT INFORMATION: This is not investment, tax, or legal advice. Should you have questions, please consult your own attorney, tax accountant, or other appropriate expert having expertise in the area of your question or before making important decisions in these areas.