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Introduction There are many traps for the inexperienced business person, and unfortunately the IRS will not accept ignorance as a defense for fraud when they are evaluating your home business expense deductions. This article addresses many accounting and tax related concerns by offering smart suggestions and detailed explanations. You may find however that the information given here leads to more questions, and as you certainly know, tax regulations are not for the faint-hearted or the dull-witted. We have developed a short list of allowable and important business related deductions for you. You can read only the relevant sections as you need them, or you can browse the entire article for a fuller picture of home business related expenses and applicable deductions. You might be surprised at what deductions you are allowed to make! This article will be a valuable weapon in your fight with the taxman, as well as an invaluable resource when planning your business activities, and we hope you will enjoy this reference tool enough to recommend it to others. Home Business Related Deduction Schemes The Internal Revenue Service has issued a variety of consumer alerts regarding home based business schemes that appear to offer relief from taxes. Unfortunately, the reality of this is that the promoters of these schemes provide bad advice to unwary taxpayers, which if followed, can result in fraudulent business deductions and criminal tax avoidance. Taxpayers, who own a home based business, have been warned to carefully consider the consequences of filing a federal tax return filled with unallowable deductions. Initially, many of these tax schemes appear quick and easy. Yet, crossing the line with bogus business or non-existent business expenses will eventually result in the business owner paying interest and penalties on top of the taxes they owe. It pays to take the time to get it right the first time! Some examples of personal expenses that are not deductible, but, are commonly claimed as home business related deductible expenses include the following: 1. Deducting all or most of the cost and operation of a personal residence. For example, placing a calendar, file cabinet and telephone in every room does not increase the amount of the home space that can be deducted. 2. If the business is not real, deducting any portion of the total home mortgage or rent is not allowed. 3. Paying children a salary for services, such as answering telephones, washing cars, running errands and other such tasks and then deducting their salaries as a business expense is not a legal deduction. 4. Deducting educational expenses from the salaries wrongfully paid to children as employees is also not acceptable. 5. Excessive car expenses when the vehicle has been used for both business and personal matters are a common deduction that are not allowed. 6. Operating under the mask that "everyone is a potential client" does not allow for deducting personal travel, meals and entertainment. The IRS has also seen a number of illegal schemes that instruct employers not to withhold federal income tax or other employment taxes from wages paid to their employees. Such advice is based on an incorrect interpretation of Section 861 and other parts of the tax law and has been refuted in court. Employers can be held responsible for back payments of employment taxes, plus penalties and interest. It is worth noting here that employees who have nothing withheld from their wages are still responsible for payment of their personal taxes. Return Preparer Fraud Return Preparer Fraud generally involves the preparation and filing of false income tax returns by preparers who claim inflated personal or business expenses, false deductions, unallowable credits or excessive exemptions on returns prepared for their clients. Preparers may also manipulate income figures to obtain fraudulent tax credits, such as the Earned Income Tax Credit. In some situations, the client or taxpayer may not have knowledge of the false expenses, deductions, exemptions and credits shown on their tax returns. However, when the IRS detects the false return, the taxpayer must pay the additional taxes and interest and may be subject to penalties and criminal prosecution. In other words ultimately, regardless as to whether you know what was on the form or not, you are responsible for the claims made on your return. While most preparers provide excellent service to their clients, the IRS urges taxpayers to be very careful when choosing a tax preparer. You should be as careful as you would in choosing a doctor or a lawyer. It is important to know that even if someone else prepares your return, it will be you who is held legally responsible for its contents.. Helpful Hints When Choosing a Return Preparer No matter who prepares your tax return, you the home business owner and taxpayer, are ultimately responsible for all of the information on your tax return. 1. Never sign a blank tax return. 2. Avoid tax preparers who claim they can obtain larger refunds than other preparers. 3. Avoid preparers who base their fee on a percentage of the amount of the refund. 4. Use a reputable tax professional who signs your tax return and provides you with a copy for your records. 5. Consider whether the individual or firm will be around to answer questions about the preparation of your tax return months, or even years, after the return has been filed. 6. Review your return before you sign it and ask questions on entries you don't understand. 7. Find out the person's credentials. Only Attorneys, CPAs and enrolled agents can represent taxpayers before the IRS in all matters including audits, collection and appeals. Other return preparers may only represent taxpayers for audits of returns they actually prepared. 8. Find out if the preparer is affiliated with a professional organization that provides its members with continuing education and resources, and holds them to a code of ethics. 9. Ask questions. Do you know anyone who has used the tax professional? Were they satisfied with the service they received? Take up references if you have no personal connection. Tax evasion is a risky crime, a felony, punishable by five years imprisonment and a $250,000 fine. Incarceration may include prison time, home confinement, electronic monitoring or a combination. Is it wrong to deduct costs associated with home based businesses? The law allows individuals to claim legitimate business expenses. In order to be deductible, expenses must be ordinary and necessary expenses paid and incurred in carrying on a legitimate trade or business. A business must truly exist prior to claiming business related expenses. Legitimate deductions may be limited and could have a number of qualifiers or categories. Always seek assistance from qualified and legitimate tax professionals before claiming these deductions. What should a person do if they have deducted home business expenses on a return that are actually non-deductible personal expenses? File an amended return. If the amended return results in additional tax owed, the taxpayer may also be subject to interest and penalties. However, amending a return may reduce the amount of penalties and interest eventually owed. For additional guidance on amending returns, seek the advice of a trusted tax professional. What if the home business owner does not amend their return? If the return is audited, the possible penalties, interest, and legal costs associated with an abusive tax promotion can be significant. Criminal sanctions may also apply including: criminal penalties, imprisonment, and fines. This is in addition to the tax due and fees paid for the promotion. Contact a competent professional for help. Since this article is designed for people with a home based business, and not employees who work from their homes for the convenience of their employers (telecommuters), we will cover only a few important areas and not devote too much time to deductions for persons considered "employees", based on the above classifications. Also, for the purpose of this article, "contractors", as described above, are assumed to be home based business owners and entitled to all deductions detailed here. However, we strongly recommend that any contractor contacts an accounting professional for assistance in determining whether their status is either as an employee or contractor. In addition, if you are a contractor and responsible for filing quarterly estimated tax payments, you might need professional guidance to establish these filings and further aid you in calculating which home based business expenses are allowable tax deductions for you and your business. Allowable Deductions Any legitimate expense used to insure that your business succeeds is deductible from your federal income tax and many of them are 100% deductible. Since every deduction will be subtracted from the gross income your business generates, it is absolutely essential for you to learn how to correctly identify all of your allowable expenses. As a business owner, you will find it is impossible to operate without purchasing equipment and supplies. You may even find yourself having to take a business trip to attend a seminar or to close a deal. Such necessary expenses are allowable deductibles and as long as these items are correctly documented and recorded they are provable, so your Uncle Sam will gladly allow you to use these deductions to reduce your federal income tax liability. Non-Deductible Expenses Your family and personal expenses are not deductible. The primary rule-of-thumb is: Does this expense benefit your business? If the answer is "No" then it is not deductible as a business expense. Of course the Government will allow you to deduct personal items such as mortgage interest, charitable contributions, medical expenses and many other items on your personal federal income taxes. However, these personal items are not allowable business deductions and are not covered in this article. Your Business Profits The federal income tax laws recognize you must spend money to make money. Virtually every home business, however small, incurs some expenses. Even someone with a low overhead business must buy paper, computer equipment, office furniture and basic supplies. Some home businesses may incur substantial expenses, even exceeding their incomes. Individuals who do not own a business pay taxes before they ever see their regular paycheck. They do not have the same flexibility an entrepreneur does. Of course, they do not take the risks a business owner does. So, as a business owner, you are rewarded by knowing how to make your business expenses work for you. In fact, as small business owner who really understands deductions and taxes, you can control how much taxes you will pay. A business person whose net income is $50,000 annually can enjoy a lifestyle similar to a wage earner with an annual salary of $75,000. Why? Because as a business owner you can structure your net income so you only pay taxes on a small fraction of the income actually earned, in comparison to the wage earner. This is possible only if you have done your homework and know how to record all expenses for maximum, allowable deductibles. To help you understand how this can work for your home business, a basic step-by-step example is provided below. Example Joan started an e-Commerce business and grossed $60,000 this year. With a portion of her income, Joan made the following purchases. She spent $20,000 on current expenses, which included: print advertising (such as business cards, letterheads, invoices and yellow page advertising in phone directories); computer equipment; furniture and office supplies (paper, printer ink, staples, paper clips and such). Joan only has to pay taxes on the remaining $40,000 her new business generated. The $20,000 in deductible expenses she spent on business related items are needed to help her home based business survive and possibly even flourish. Had she earned $60,000 from an employer, Joan would have to pay taxes on a higher percentage of her earned income, and quite possibly, the entire $60,000. Record Keeping To have good records, you must track your income and expenses. Federal law only allows you to deduct the business expenses that you can prove. In order to be able to prove you had a real and legitimate expense, you must keep records. These records simply track how much you really spent, where you spend it and why it was necessary to do so. These records will be golden proof of allowable expenditures if you are ever audited by the IRS. There is no particular method of bookkeeping you should use, however, it is important that you use a consistent method that clearly and accurately reflects all of your income and expenses. You may receive income from many different sources and your records will identify these sources so that you can separate business from non-business income and taxable from non-taxable income. It is also very easy to forget to record expenses, but you will find that if you record it when it happens, your records will never skip or incorrectly identify those expenses for which you may claim deductions. The law does not require you to keep your records in any particular way. Keep them in a manner that allows you and the IRS to determine your correct tax. You can use your checkbook to keep a record of your income and expenses. In your checkbook you should record amounts, sources of deposits, and types of expenses. You also need to keep documents, such as receipts and sales slips, that can help prove a deduction. Keep your records in an orderly fashion and in a safe place. You will need to keep them by year and type of income or expense. One method is to keep all records related to a particular item in a designated envelope for easy access and filing. You have many record maintenance options available to you, from expensive, pre-bundled software to a simple spreadsheet or even a handwritten, spiral notebook. If you use a computerized system, you must be able to produce legible records of the information needed to determine your correct tax liability. In addition to your computerized records, you must keep proof of payment, receipts and other documents to prove the amounts shown on your tax return. Well organized records will make it possible to know if your business is operating profitably and make it easier to prepare your tax return. In addition, these records may be the deciding factor in your ability to get a loan or lower your insurance premiums.
Article Source: http://www.accountingsoftwarearticles.com
About the Author Marvin Mitchell is a former IRS Tax Examiner. His e-book entitled "eBusiness Write-offs Made Simple" was written to help home business owners learn the strategies they need to benefit from all the tax benefits the U.S. Government provides. Visit www.etbglobalu.com/DiscountedEbook.php for details.
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