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September 2009 - Volume 6 - Issue 3


The General Rules for Business Deductions

For all small business owners, the biggest headache for keeping your business afloat is managing the finances. Determining your taxable income, figuring out your grossing profit and sorting out your receipts all seem like busy work you pay your accountant to do. With todayís edition of the Taxís Guru I will highlight the general rules of business deductions.

The first step in managing your finances is determining your gross profit for the year; that is income that you receive from sales to your customers, minus the cost of goods sold. Once you get that figure, we can then begin the exciting task of sticking it to Uncle Sam and whittling that profit down for tax purposes by subtracting all your deductible business expenses.

When deciding if an expense is deductible there are three rules to follow. So you run a nail salon and you purchased 10 yearly magazine subscriptions are these deductable items, yes. This type of purchase falls under the clause ordinary and necessary. The IRS is rather flexible in this regard and defines ordinary as common and accepted in a field of business, and necessary as helpful and appropriate to your business. Magazines are a necessary business expense that promotes a healthy customer experience adding to your profitability. On the flipside the cost of a gun purchased for personal protection by an insurance agent, who travels to rough areas at night would not be deductible. While the expense of the handgun might be "ordinary," it is not "necessary" because itís not helpful or appropriate to selling life insurance. It would be considered a nondeductible personal expense.

You have a home office where 60% of your work is conducted, you want to deduction 100% of our utility bills as a business expense, nice try but you can not. The worst struggle for a home based business is clarifying if an expense is business various personal. Its so tempting to write off the remodeling of the deck as a tax expense because we held a business lunch on it or the purchase of a flat screen TV for the family room because you screened training materials with it. Big brother is always watching and waiting for you to slip so itís important to allocate the expenses appropriately between business and personal.

You donít need a degree from Harvard to master the artful skill allocation. There are many measurements for allocating expense including time, space or usage. For example, if you have an employee who cleans your office and also cleans your house, you can deduct the portion of the employee's wages and payroll taxes that compensate for the hours spent cleaning the office, but not the home. If you drive your car for both business and personal purposes, you must allocate your car expenses on the basis of the mileage driven for business purposes, as opposed to that for personal or commuting purposes. As a rough rule of thumb, if you still had to pay for the expense or service if you were unemployed itís probably a personal expense and canít be deducted.

The word every American fears, AUDIT, doesnít have to be frightening. The third rule for general deductions is having adequate records. Your word is not enough; having proof of payment written on a receipt, post it or shirtsleeve will suffice. All taxpayers are required to keep accurate, permanent books and records to determine the various types of income, gains, losses, costs, expenses, and other amounts that affect their tax liability for the year. Commonly, these records should be retained for at least four years, since the IRS may challenge your return for up to three years after its due date.

In order to claim any deduction, you should be able to prove what the expense was for, and that the expense was in fact paid. A receipt or invoice showing the description and cost of the item, plus a canceled check or credit card charge slip, are your best bet. There are certain situations like incomplete inventory purchases for retailers that are obvious and the IRS will overlook but things like travel expenses, meals, cellular phones and transportation costs must be documented to be deducted.

All in all it is your responsibility to maintain your business expenses. When the men in black are looking for the culprit it will be you not the bookkeeper held responsible. Understanding the appropriateness of the expense, business verses personal expenses and adequate record keeping are the keys to staying afloat.

Eric Yankwitt, Advisory Tax Service, Inc., can be reached at (954) 763-2829 ext. 201 or or visit www.MyTaxGuru.Com.
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