Often times, setting up and operating a small business feels more like a do-it-yourself and learn-as-you-go enterprise. While this freedom provides flexibility to adapt to changing market environments, it can also put a lot of weight on your shoulders especially when it comes to business planning and taxes.
To help lighten your load, FindLaw has prepared answers to some common questions you may have about small business taxes.
What's considered a tax deductible small business expense?
According to the tax code, just about any business expense that is "ordinary, necessary and reasonable" will qualify as a deduction that will decrease the profits of your business for tax reasons. But what are considered ordinary and necessary expenses? According to the Internal Revenue Service (IRS), these are any expenses which are "helpful and appropriate" for you business.
For example, if you purchase a new computer for your small business, or buy stationary to send out your mailings, these expenses would probably be considered ordinary and necessary. However, if you buy a new computer for your son to use in his room, this would not be a business expense even if you ran your small business from home.
There are a few expenses that are explicitly prohibited from being considered an ordinary and necessary business expense, such as:
I use my personal car in my business -- is that a tax deductible business expense?
The short answer is yes, but you'll need to do some calculations to determine how much can be deducted. This can be determined by using either the standard mileage method or the actual expense method. There are some situations when you must use the standard mileage rate, like when claiming a Section 179 deduction in the previous tax year.
The standard mileage method is most commonly chosen because of its easier record-keeping requirements. Under this method, you can deduct a set amount for each business mile that you drive. For the 2016 tax year, the standard mileage deduction rate was 53.5 cents per business mile.
If you use the actual expense method, you're allowed to deduct the actual costs you incur each year to operate your car for your business, plus depreciation. This can include costs for:
However, if any of these expenses were related to your personal use of the car, they could not be included in your deduction calculation.
Regardless of the method you choose, you'll need to maintain records justifying your business related expenses in case you're audited. This can get complicated if you use the vehicle for personal and business use. The simplest way to address this is to keep a mileage log showing how many miles you used your car for business purposes, and how many for personal purposes.
In addition, you're also allowed to write off the depreciation of the cost of the vehicle over a number of years.
Can I claim a deduction for business-related entertainment?
Yes, but only a limited amount. Under the IRS rules, you are only allowed to deduct 50% of expenses that you incur for entertaining clients or customers. Some examples of qualified business entertainment expenses include taking potential clients to a baseball game, dinner at fine restaurants, or even bringing over some of your best customers to your home for a BBQ and football on TV.
When claiming these business-related entertainment deductions, you should keep in mind that you need to have documents showing that the entertainment was related to your business in case you are audited. With this in mind, be sure to keep a guest list (including the business relationship), and any receipts.
What's the difference between current and capital expenses?
To answer this, it's best to look at each type of expense. Current expenses are those that can be deducted from your business' total income in the year they are expended. These would include the everyday costs of keeping your business going, such as:
Any money that you spend that will help generate revenue for your business in the future, such as a copier or a car, are called capital expenses and must be written off over their "useful life" which is normally three, five or seven years.
However, there is an important exception to the normal capital expenses write off rules. A Section 179 deduction allows you to fully deduct capital expenses in the year that you incur those expenses.
I'm planning on taking a trip to trade show. Can I take my family along as a vacation and still deduct my expenses?
Yes, however, if you take your family along on your business trip, you can only deduct as much as you would if you'd taken the business trip on your own. This leads to some imaginative planning. For example, if you drive your family to the trade show in one car, and you all stay in one standard hotel room, then you can deduct your expenses related to the automobile as well as the hotel stay. However, you wouldn't be able to deduct the meals your family eats, nor any trips to the local water park. In addition, if you plan on staying after the trade show ends so that you can enjoy some time with your family, you can't deduct these nonbusiness expenses.
If my business requires me to work from home, am I allowed to take a home office tax deduction?
This depends on how you use your home for your business. If you run your business out of your home, you may be able to take the home office tax deduction. This deduction allows you to deduct part of your expenses for rent (or mortgage payments), utilities, insurance and even remolding.
In order for you to take the home business tax deduction, however, you must follow strict requirements. As an example, you will not be eligible to take the home business tax deduction if you use your home office partly for work and partly for personal use.
I'm thinking about starting my own small business, so how can I avoid trouble with the IRS?
One thing that many small business owners learn in order to stay out of trouble is the importance good record keeping. Indeed, many small business owners end up in trouble with the IRS simply because of poorly kept records, even where there's no attempt to evade or defraud.
Many small business owners decide not to keep their own records and instead hire a professional record keeper to do the dirty work. However, if you're computer savvy, there are a number of programs you can use to keep your own business records.
You should always keep business records organized and in a safe place. These records can include receipts, canceled checks, or other documents related to business expenses. It's helpful to keep them organized by category, such as:
If the IRS ever shows up for an audit, they are most likely to focus on expenses related to your car, travel costs, and entertainment. As always, the burden of providing records verifying your deductions falls on you, not the IRS.
Will I get any tax breaks for incorporating my small business?
The main problem that many owners run into when they think about incorporating their small business for tax benefits is that their businesses are not always well established. The tax benefits that come from incorporating are really geared towards companies that are profitable from year to year.
For example, corporations can offer pension plans that are more tax flexible, but most small businesses rarely have the revenue to take advantage of this tax break. In addition, corporations have the option of keeping some of their profits inside the corporation in order to take advantage of the lower corporate tax bracket. However, many small business owners cannot do so because the business has not shown the ability to maintain a steady profit.
The process of incorporating and maintaining your corporate status comes with costs. Therefore, you should really only think about incorporation for the tax benefits if you're sure that your business is profitable and will maintain is profitability.
Is it a good idea for me to keep my own books for my small business and file my own taxes?
If you're planning on keeping your own books, you should really invest in a good bookkeeping program. In addition, because these programs can be quite confusing, you should also think about taking a class to help you learn the program. When you're ready to do your taxes, you should also invest in tax software.
Another step that you can take to make sure your bookkeeping system is on the right track is to hire a professional bookkeeper to review everything. Indeed, many small business owners that keep their own records hire a professional for a few hours to make sure their bookkeeping system is properly set up. In addition, many times these professionals can show you how to take your bookkeeping system and apply it to a tax program.
If I hire people for a big project coming up, are they considered employees or independent contractors?
The answer to this question really depends on how you treat the workers. For example, if you're going to be telling the workers where, when and how to perform their job duties, then you should treat them as employees because that is how the IRS will classify them. You should really only treat workers as independent contractors if they have their own business and offer their services to several clients. When in doubt, you should probably err on the side of caution and treat your workers as employees.
Many small business owners are tempted to classify workers as independent contractors in order to save money in the short run. However, if you run into trouble with the IRS for misclassifying workers, you'll probably end up losing more money than you saved. If the IRS feels that you misclassified workers, they can reclassify them as employees and impose back taxes, penalties and interest against you.
Get Legal Help with Your Small Business Tax Questions
Whether you're considering starting a new business or have questions about how to classify independent contractors, you'll want to have the most accurate information about the laws available to you. The best way to have your questions answered is to contact an experienced tax attorney who can give you answers specific to your situation.