Tax Tips for Small Business Owners

Organization

In order to maximize tax deductions, it is imperative to keep good records.  You should choose a "system" that works for you, and keep it as simple as possible.  There is no need to complicate the process that to some is already a daunting task.    Some choose to utilize accounting software, some use spreadsheets, some use other tools, but whatever the tool, the outcome should be the same; a clear and concise record of the amount of income and expenses relating to your business activity. In addition, good records will help you monitor the progress of your business, prepare financial statements, keep track of deductible business expenses and prepare your tax returns.

Planning

We have all heard the quote, "Failing to plan is planning to fail"  Tax planning provides you concepts and strategies to minimize your taxes.  Taxes are probably one of the largest expenditures, so it makes sense to focus some time and resources on where you spend the most.  Do you ever think to yourself, if I spend $1,000 on a business expense, how much that saves in tax dollars?    Being proactive is so important to the viability of a small business.  I routinely work with clients throughout the year to discuss their overall tax situation and discuss tax strategies that will help minimize their taxes.  While it might already be too late to limit what you will owe Uncle Sam for 2010 taxes, now is the time to start thinking for ways to save on taxes in 2011.

Tax Benefits

Provided certain conditions are met, taxpayers may be eligible to deduct qualifying expenses associated with maintaining their home office. Home-related business deductions generally are allowed only with respect to a portion of a home that is used exclusively and regularly:

(1) as the principal place of business for the taxpayer's trade or business;
 
(2) as a place to meet or deal with clients, customers, or patients in the normal course of business; or
 
(3) in the case of a separate structure that is not attached to the dwelling unit, in connection with the taxpayer's trade or business 

A home office qualifies as a principal place of business if the taxpayer uses it exclusively and regularly for administrative or management activities. Also, the taxpayer may not have any other fixed location where he or she can conduct substantial administrative or management activities of the business. 

If the taxpayer fails to use a portion of the home exclusively in a trade or business, the taxpayer may still qualify for a home office deduction under one of two exceptions to the exclusive use rule. The first exception is for use of part of the home on a regular basis to store inventory or product samples for the taxpayer's trade or business of selling products at retail or wholesale. In this case, the home must be the only fixed location of the trade or business. The second exception is for use of the home as a day care center.

Type and allocation of expenses.

The expenses related to the business use of the home must be categorized as direct or indirect expenses. Direct expenses include those expenses directly related to the home office, such as the costs of repairs, paint, or additional insurance specifically for the home office. Indirect expenses include those costs required to operate the entire home, and may include real estate taxes, mortgage interest, casualty losses, rent, repairs, security systems, telephone, utilities, waste removal services, cleaning services, insurance, and depreciation. Indirect expenses are allocated to the home office deduction based upon a reasonable method, such as the percentage of square feet dedicated to the business. Expenses are deducted from the gross income generated by the business in a prescribed order. The home office deduction cannot create a net operating loss, therefore any expenses in excess of the gross income must be carried over to the following tax year.

If you own your home and qualify to deduct expenses for its business use, you can claim a deduction for depreciation. Depreciation is an allowance for the wear and tear on the part of your home used for business. You cannot depreciate the cost or value of the land. The basis for depreciation is the lesser or the adjusted basis, including improvements, of the portion of the home allocated to the office space; or the fair market value of the portion of the home allocated to the office space at the date the property is placed in service.  Although this provides a tax benefit, it does create tax consequences when the residence is sold.  Any gain to the extent of depreciation attributable to periods after May 6 1997, is not eligible for principal residence gain exclusion, but is taxed at a maximum rate of 25%.

No business owners want to pay more tax than they have to, yet many do because they don’t take advantage of all the tax deductions that are available to them.  Saving taxes requires a proactive approach and knowledge of the various tax planning strategies.  Whether you decide to follow one of these tips or all of them, be sure to start planning for 2011 now. Review these ideas with your tax advisor today.