TO DO TAX PLANNING

TAKE ALL THE LEGITIMATE

BUSINESS EXPENSES YOU CAN

Some might say that the list of potential business expenses is limited only to what the mind can perceive. That would be a big stretch.   Believe it or not, the IRS knows your business better than you do.  That is to say, they know what expenses are ordinary and acceptable for your type of business.  After all, they have audited millions of businesses over the years.  So, when it comes to deciding what business expenses you can legitimately take, why not start with IRS publications and other documents to find out what the IRS will allow.  You may even find some expenses you never thought of taking. 

To be deductable, expenses must be “ordinary” and “necessary.”  That is, to be deductable, the expense must be normal, usual and customary for the type of business you are in (that’s the ordinary part) and it must be necessary for your specific business. 

I have created a generic list for you to use as you prepare to do your taxes.  Use this as a checklist to make sure you have not forgotten anything.  I will be updating the list from time to time to insure it is as complete as possible although I’m not trying to cover every niche business.  I’m sure there are some unique expense items that I haven’t even thought of, but this list will be a good starting point for all of you to review to ensure you don’t miss any of the big ticket items.  If any of you want to add to the list, send me an e-mail and I’ll be glad to do so. 

Sometimes, depending on your business entity, expenses are handled differently, that is to say, they might do on a different part of your return.  Feel free to contact me if you have any questions. 

Let me start by giving you links to some IRS publications that you might find useful:

1. Pub 538 – Accounting Periods and Methods – http://www.irs.gov/pub/irs-pdf/p538.pdf
2. Pub 535 – Business Expenses – http://www.irs.gov/pub/irs-pdf/p535.pdf
3. Pub 587 – Business Use of Your Home – http://www.irs.gov/pub/irs-pdf/p587.pdf
4. Pub 463 – Travel, Entertainment, Gift and Car Expenses – http://www.irs.gov/pub/irs-pdf/p463.pdf
5. Pub 334 – Tax Guide for Small Businesses – http://www.irs.gov/pub/irs-pdf/p334.pdf
6. Pub 583 – Starting a Business & Keeping Records – http://www.irs.gov/pub/irs-pdf/p583.pdf

So here’s the list: 

 Cost of Goods Sold (generally for those who make or build something)

            Cost of products or raw materials

            Storage

            Direct labor – labor involved in manufacturing the product

            Factory overhead – the costs of running the factory

            Capitalization of direct costs for certain production activities

            Inventory

            Freight in

Dump fees

Employees pay including certain fringe benefits

Owner’s salary – only if the business entity is a corporation or subchapter S corporation.

Owner’s draws, per se, are not a deductible expense

Independent Contractor fees

Consultant fees

Advertising

Commissions and fees

Generally, penalties are not deductible

Professional services

            Bookkeeping

            Accounting

            Tax preparation

            Legal

            Professional photographer

            Web designer

Partnership guaranteed payments (only in partnership returns)

Rent

Taxes on leased property

Cost of getting a lease

Improvements by lessee (generally amortized)

Equipment rental

Interest

            Mortgage interest (for business real estate)

            Vehicle loan interest (business vehicles; to extent used in the business)

            Capitalization of interest

            Prepaid interest

            Credit line and business loan interest

Taxes & licenses

            Real estate taxes (business assets)

            Employment taxes

            Other business related taxes

            Business licenses

            Building permits and fees

Insurance

            Business insurance (for example, E&O insurance)

            Auto insurance (prorated for business use)

            Self employed health insurance                                 

Capitalized expenses (amortizing or depreciating them over a proscribed period of time)

            Business start-up costs

            Business organizational costs

            Business assets

            Improvements

                        Capital vs. Deductible expenses

Amortization

            Intangibles such as Goodwill

Business bad debts are handled differently depending on the accounting method you use

             Cash basis – not deductible – income is not recognized until money received

            Accrual basis – deductible because income recognized when earned

Repairs (vs. capital improvements) and maintenance

Repairs keep the property in good working condition without materially adding to the properties’ value.  Examples include painting, fixing a leak, replacing broken items, etc. 

Personal vs. business expenses – be very careful not to intermingle the two.

Personal expenses are never deductable as business expenses, although many people try

Charitable expenses

With the exception of a C Corporation, charitable expenses will carry to your Schedule A.

Depreciation

            MACRS

            ADS

            Assets to be depreciated

                        Software

                        Office equipment

                        Furniture

                        Automobile

                        Manufacturing equipment

                        Buildings

                        Capital improvements

Bonus depreciation – only used when allowed by IRS

Section 179 depreciation

            Allows full amount to be taken in current year – subject to limits

Depletion

Pension & profit sharing plans – treatment depends on business entity

            SEP

            IRA

            401K

            SIMPLE

Employee benefit programs – treatment depends on business entity

            Insurance

            Health and welfare programs

Reimbursable business expenses through a formal reimbursement plan

Domestic production activities credit

Business credits – there are many types of business credits

Travel (must be for a business purpose)

            Airline tickets

            Rental car       

            Hotel/motel

            Taxi

Meals and Entertainment (generally limited to 50% of actual expenses)

            Travel

            Entertaining customers or meeting with colleagues

Office in home (OIH) expense

Business must be profitable before you can take OIH expenses in current year

Special rules apply See my blog http://www.professionaltaxservicesinc.net/2009/08/office-home-expense/

Automobile and truck expenses

            Mileage vs. actual (allowable expenses to maintain and operate vehicle)

                        Actual almost always exceed mileage but you must keep good records

                        You must keep written records either way

            Auto loan interest

            Leasing expenses

Parking fees and tolls 

Miscellaneous Expenses         

Bank charges

Business start-up expenses (if under $5000 and not amortized)

Business Bond

Consulting fees

Credit and collection costs

Credit card processing fees

Damages

Delivery (Freight out)

Discounts

Documents

Dues and subscriptions

Dump fees

Exposition (show) fees and expenses

Equipment rental

Federal (FUTA) and State (SUTA) unemployment taxes

Ferry fees

Gifts

Limited to $25 per client or customer

Internet fees

Janitorial

Labor & Industry taxes

Laundry & dry cleaning

            Only for specialized clothing

Maintenance

Marketing

Meeting expenses

Miscellaneous

Office expenses

Organizational expenses (if not amortized)

Pay pal fees

PO Box

Postage and delivery

Printing

Professional memberships (special rules apply)

Professional education (Continuing professional education)

Professional supplies and publications

Real estate agent fees

Sales & promotion expenses

Security

Small tools & equipment

Staging costs

Storage

Supplies

Surety bond

Telephone

            Cell phone

            Second phone in home for business

            Fax line

Training & professional education

Utilities

Waste disposal

Web hosting

Website costs

Work clothing (special rules apply)

Well, I’m not going to tell you that there is no such thing as luck.  There certainly is.  But what if I told you there are things you can do to help make your own luck?  Let me tell you about luck.  On one particular night mission in Vietnam, my airplane was suddenly surrounded by tracers; bullets being fired in front of me and on both sides.  And to make matters even scarier, only one bullet in five is a tracer.  I quickly maneuvered the airplane in a Split S (rolled inverted pulled hard until I was headed in the opposite direction) and to my surprise, when I landed, and thoroughly checked out the airplane, I had not been hit by a single bullet.  Now that’s luck!  Or maybe I made the right move just in the nick of time.  Regardless of what it was, I know God was my copilot that night. 

Some years ago, I was very envious of a peer of mine who always seemed to get the breaks.  No matter what that guy did, he always seemed to come out on top.  It wasn’t just once, or twice, but this went on for quite some time.  I was having a discussion with a mentor of mine, someone who had been around the block a few times and was a lot wiser than I.  I happened to let it slip that I was jealous of so-and-so because he always got the breaks.  My mentor’s response surprised me.  He said “Bill, luck is when preparedness meets opportunity.  Bob is just better prepared than you and the others are.”  Wow, that was really an eye opener.  I had never thought of it that way.

After hearing what my mentor had to say, I realized that to a certain degree, I could control my own luck.  I could at least be better prepared to handle situations before they happened.   Here is a good analogy.  When US Air flight 1549 lost both engines and “Sully” Sullivan ditched his Airbus 320 into the Hudson River, was that luck?  Maybe a little, but Sully was prepared for such an emergency.  Through hours and hours of emergency procedures practice in the simulator, Sully had the experience to deal with a very serious situation.  Had he practiced that particular emergency before?  No.  But because he practiced many different kinds of emergencies, he was able to maintain calmness and a level head as he dealt with this new situation.  Not only that, but Sully thought through those kinds of scenarios in his own mind to mentally prepare himself.  Was there any luck involved?  Of course there was some, everything had to be just right for this to happen, but if it weren’t for Sully’s preparedness, no one would have survived that ditching in the Hudson.  You can bet that pilots are now practicing something similar in their simulator training now. 

So what can you do to prepare yourself for the unknowns in your life and business? 

1.  There is an old adage, “plan for the worst and hope for the best.”  In the flying business this is exactly what we do.  Most emergencies cannot be practiced in the airplane, for obvious reasons.  They are, instead, practiced in the simulator.  Modern day simulators are so realistic that pilots quickly forget they are in the simulator and think they are in the airplane.  By practicing the worst possible emergency situation in the simulator, when a pilot is faced with a real life emergency in the airplane, he/she is able to deal with it in a calm, level headed manner.  Most of the time, the emergency is far less severe that what has been practiced in the simulator and can be handled with apparent ease.   Yes, I know, I got off track a bit there.  I realize you don’t have a simulator for your business. So what do you do?  Know your business well.  Know what is important and what will keep your business on track and growing.  Concentrate on those things.  Don’t let life’s little emergencies sidetrack you in your efforts.  Think about what you are going to do and say when you finally meet that one big client have been hoping to land. Think through how you are going to respond to that client in various scenarios.  In other words, be prepared.  Don’t leave anything to chance. 
2. Have a business plan. Understand your business and know what is important to move your business forward.  Think about what can go wrong.  Have a contingency plan for all those things that could go wrong.  Every now and then, climb up to 30,000 feet and take a total view of your business.  Remember, it’s hard to see the forest through the trees.  While at altitude, so to speak, make a calm assessment of your business.  In your day to day operations, whatever you do, don’t let the mundane, unimportant things bog you down.  When you see you are getting off track, make adjustments to your plan.
3. Stay focused.  One of the airplanes I flew in my Air Force career was AWACS.  It is a four engine 707 with a large rotodome on top and is the USAF equivalent to a Navy aircraft carrier; always being sent to the hot spots.  I was the chief pilot for the AWACS program in both the USAF and NATO.  That meant that I had the responsibility to evaluate other pilots and flight crews.  During the evaluation flight we always threw in a simulated emergency or two.  On occasion, we experienced an actual emergency.  Sometimes I could see the entire four man flight crew focus totally on the emergency, leaving only the autopilot to fly the airplane.  This is how a simple emergency can be turned into a disaster.  It is so easy to get caught up in the moment and forget about the big picture.  You must remain focused on the important things in your business.    

So next time you start to get envious of someone else who always seems to have good luck, know that good luck can be yours as well by preparing yourself properly.

So, why in the world would I be talking about flying in combat in a multi-aircraft formation when I should be talking about business? Whether you know it or not, as a business person you are in a type of combat, because you are in stiff competition with others, everyone competing for the same customers and dollars. A recent article in the Wall Street Journal, “With Lobster Prices Low, Things Get Ugly in Maine,” by Simmi Aujla, points out the hazards of competition. Lobster prices are so low the fishermen are actually fighting one another. This is certainly an extreme situation, but we in small business are fighting for our survival, against our competition while dealing with a myriad of other factors. For example, we fight on a daily basis to keep up with local, state and federal regulations. So why are you going it alone? Just like fighters going off to combat, you need to arm yourself with a team of advisors. A good team of advisors can be “checking your six”, so to speak, and keeping you and your business out of trouble.

How do you go about forming a team of advisors and how should you use them? Each business and business owner is unique. The first thing you should do is assess your strengths and weaknesses and in any area you rate yourself as weak or even average, I would consider having an advisor.

What kind of advisor should you look for? You should look for a professional who has experience in small business and is at least familiar with your business.

I assume you are an expert at what you do or you would not be in your business. But perhaps you have decided to branch off into a new field. In that case I would definitely find someone, in the same field, who is not a direct competitor, to use as a resource. Pick that person’s brain to find out as much as you can about your business.

If you are strong in recordkeeping and enjoy doing it, that’s great. If not, bring a bookkeeper on board to do your bookkeeping for you, review your books periodically or, if not that, at least be available to give you advice how your books should be set up and kept. Good bookkeeping is critical to a successful business. Why would you want to cut yourself short here?

The same thing goes for taxes. Perhaps you have been operating your business long enough to know what you need to file and how to plan for your taxes, but if this is an area of weakness, bring a tax professional on your team to be there when you have a question. A tax professional experienced in small business can provide invaluable advice. For example, are you in the right business entity? Are you doing proper tax planning? Are you taking all the deductions you can legally take and does the business entity you have chosen help to minimize your taxes? You may be surprised what you learn.

If you are in a business that requires capital, get to know a banker or other source of capital. Even if your business does not require a lot of capital, you need to make sure you have a line of credit, a credit card or some other source of money to get you through the low income, high expense periods.

What about your E&O or similar insurance. Do you have someone you can call to give you straight forward advice and who will shop around for the best price for you?

The same thing could be said for: Marketing, legal, website development, retirement plans and other benefits for you and your employees.

Speaking of employees, that brings up one final consideration. Dealing with payroll is complicated and can get you in a lot of trouble with both the state and IRS if not done properly. (see my article, “So Far, So Good” http://biznik.com/articles/so-far-so-good ) Don’t be afraid of payroll. My advice, hire a professional to do your payroll for you or at least to get you set up properly. This could be your bookkeeper or a professional payroll service. If you do it yourself, make sure you know what you are doing and/or follow the advice of the advisor to the letter. Remember, if you are a Subchapter S Corporation, you are an employee of the Corporation and must pay yourself a reasonable salary, assuming you are making a profit in the business.

I could go on and on, but I think you get the picture.

Take a few minutes and do a self assessment. Try to think of everything you need to do to make your business successful, including the not-so-fun stuff like bookkeeping and taxes. Look at your list to see where you have rated yourself as weak or average, then try to think of someone you could call on as a resource in that area. Perhaps it’s a friend, perhaps an acquaintance or someone you have met through Biznik.

You will use some of your advisors more frequently than others. In those areas where you know you need help and will need frequent advice and assistance, consider an arrangement where you negotiate with the professional to pay an hourly rate, an annual amount for continuous advice, or hire that person to do everything and get their advice with it. For example, if you hire me to do your taxes, you get my advice free for the year. If you don’t want me to do your taxes, you could hire me for an annual fee or pay me by the hour. There are lots of choices. Remember, you get what you pay for, so if you want advice from an expert, expect to pay for it.

Depending on your business, you could also have your team of advisors set up so that you can refer a client to them if he/she needs that type of professional advice or service. It’s great when a group of professionals refers clients to one another. Clients who trust you will tend to take your referral.

Fly safe, your team of advisors has your six!