Home Business Tax Deductions

Home Business Tax Deductions 10 th Edition Stephen Fishman, J.D.

Chapter 1 Some Tax Basics... 1 Learning Objectives... 1 Introduction... 1 How Tax Deductions Work... 1 Types of Tax Deductions... 1 You Pay Taxes Only on Your Business Profits... 2 Claiming Your Deductions... 2 Make Sure You Are in Business... 2 How Businesses Are Taxed... 2 Basic Business Forms... 3 Sole Proprietorship The Most Popular Home Business Entity... 3 Tax Treatment... 4 What Businesses Can Deduct... 5 Start-Up Expenses... 5 Operating Expenses... 5 Capital Expenses... 6 Inventory... 6 Adding It All Up: The Value of Tax Deductions... 6 Federal and State Income Taxes... 6 Self-Employment Taxes... 7 Total Tax Savings... 8 Review Questions... 10 Review Answers... 11 Chapter 2 Is Your Home Really a Business... 12 Learning Objectives... 12 Introduction... 12 Proving That You Are in Business... 12 Profit Test... 14 Behavior Test... 14 Tax Consequences of Engaging in a Hobby... 17 Investing and Other Income-Producing Activities... 18 Tax Consequences of Income-Producing Activities... 18 Types of Income-Producing Activities... 20 Trading in Stocks as a Business... 21 Real Estate as a Business... 22 Review Questions... 24 Review Answers... 25 Chapter 3 Getting Your Business Up and Running... 26 Learning Objectives... 26 Introduction... 26 What Are Start-Up Expenses?... 26 Common Start-Up Expenses... 27 Special Rules for Some Expenses... 27 Buying an Existing Business... 28 Expanding an Existing Business... 28 When Does a Business Begin?... 28 Home Manufacturers... 28 Knowledge Workers... 29 Service Providers... 29 Existing Businesses... 29 Claiming the Deduction... 29 If Your Business Doesn t Last 15 Years... 30

Expenses for Businesses That Never Begin... 30 General Start-Up Costs... 30 Costs to Start or Acquire a Specific Business... 31 Avoiding the Start-Up Tax Rule s Bite... 31 Review Questions... 32 Review Answers... 33 Chapter 4 Home Business Operating Expenses... 34 Learning Objectives... 34 Introduction... 34 Requirements for Deducting Operating Expenses... 34 Ordinary and Necessary... 34 Current Expense... 37 Business Related... 37 Reasonable in Amount... 39 Operating Expenses That Are Not Deductible... 40 How to Report Operating Expense Deductions... 40 Review Questions... 41 Review Answers... 42 Chapter 5 Deducting Long-Term Assets... 43 Learning Objectives... 43 Introduction... 43 Long-Term Assets... 43 Repairs Versus Improvements... 44 Inventory... 45 Methods for Deducting Long-Term Assets... 46 Rules for Deducting Any Long-Term Asset... 47 Disposing of Long-Term Assets... 49 Section 179 Deductions... 50 Property You Can Deduct... 50 Property Used Primarily (51%) for Business... 50 Calculating Your Deduction... 51 Recapture Under Section 179... 54 Bonus Depreciation... 55 Property that Qualifies for Bonus Depreciation... 55 Placed In Service Date... 56 Class-Wide Requirement... 56 Calculating the Bonus Amount... 56 Opting Out of the Bonus... 56 Regular Depreciation... 56 Depreciation Period... 58 Depreciation Methods... 59 Depreciation Rules for Listed Property... 61 Real Property... 61 Deducting Business Vehicles... 62 Is Your Vehicle a Passenger Automobile?... 62 Annual Depreciation Limits for Passenger Automobiles... 63 Tax Reporting and Record Keeping... 65 Leasing Long-Term Assets... 66 Leasing Versus Purchasing... 66 Leases Versus Installment Purchases... 67 Review Questions... 68 Review Answers... 70 Chapter 6 The Home Office Deduction... 72 Learning Objectives... 72 ii

Introduction... 72 Qualifying for the Home Office Deduction... 72 Threshold Requirements: Regular and Exclusive Business Use... 73 Additional Requirements... 76 Corporation Employees... 79 Calculating the Home Office Deduction... 80 How Much of Your Home Is Used for Business?... 80 What Expenses Can You Deduct?... 83 New Simplified Home Office Deduction Method... 90 How the Simple Method Works... 90 IRS Reporting Requirements... 91 Audit-Proofing Your Home Office Deduction... 92 Prove That You Are Following the Rules... 92 Keep Good Expense Records... 92 Review Questions... 94 Review Answers... 96 Chapter 7 Eating Out and Going Out: Deducting Meal and Entertainment Expenses... 98 Learning Objectives... 98 Introduction... 98 What Is Business Entertainment?... 98 Activities That Aren t Entertainment... 98 Meals Can Be Travel or Entertainment... 99 Who You Can Entertain... 99 Deducting Entertainment Expenses... 99 Business Discussions before or after Entertainment... 100 Business Discussions during Entertainment... 100 Entertaining at Home... 101 Entertainment in Business Settings... 102 Calculating Your Deduction... 102 Expenses Must Be Reasonable... 103 Going Dutch... 103 Expenses You Can t Deduct... 103 Entertainment Tickets... 104 Reimbursed Expenses... 105 Reporting Entertainment Expenses on Your Tax Return... 106 Review Questions... 107 Review Answers... 108 Chapter 8 Getting Around Town: Car and Local Travel Expenses... 109 Learning Objectives... 109 Introduction... 109 Deductible Local Transportation Expenses... 109 Travel Must Be for Business... 109 Trips from Your Home Office... 110 If You Have No Regular Workplace... 110 The Standard Mileage Rate... 111 How the Standard Mileage Rate Works... 111 Requirements to Use the Standard Mileage Rate... 112 The Actual Expense Method... 112 How the Actual Expense Method Works... 112 Record Keeping Requirements... 113 Vehicle Depreciation Deductions... 114 Leasing a Car... 114 How to Maximize Your Car Expense Deduction... 115 Use the Method That Gives the Largest Deduction... 115 Keep Good Records... 115 iii

Other Local Transportation Expenses... 115 Reporting Transportation Expenses on Your Tax Return... 115 Sole Proprietors... 115 LLCs and Partnerships... 116 Corporations... 116 When Clients or Customers Reimburse You... 116 Review Questions... 118 Review Answers... 119 Chapter 9 Leaving Town: Business Travel... 120 Learning Objectives... 120 Introduction... 120 What Is Business Travel?... 120 Where Is Your Tax Home?... 121 Your Trip Must Be for Business... 123 Deductible Travel Expenses... 124 Traveling First Class or Steerage... 125 Taking People With You... 125 How Much You Can Deduct... 125 Travel within the United States... 126 Travel outside the United States... 126 Conventions... 129 Travel by Ship... 129 Calculating Time Spent on Business... 130 Fifty Percent Limit on Meal Expenses... 130 Maximizing Your Business Travel Deductions... 132 Plan Ahead... 132 Make a Paper Trail... 132 Maximize Your Business Days... 132 Take Advantage of the Sandwich Day Rule... 133 Travel Expenses Reimbursed by Clients or Customers... 133 Review Questions... 134 Review Answers... 135 Chapter 10 Inventory... 136 Learning Objectives... 136 Introduction... 136 What Is Inventory?... 136 Supplies Are Not Inventory... 136 Incidental Supplies... 137 Long-Term Assets... 137 Maintaining an Inventory... 137 When You Provide Services and Sell Merchandise... 138 Supplies for Providing a Service... 138 Deducting Inventory Costs... 139 Computing the Cost of Goods Sold... 139 Determining the Value of Inventory... 140 IRS Reporting... 141 Review Questions... 143 Review Answers... 144 Chapter 11 Hiring Help: Employees and Independent Contractors... 145 Learning Objectives... 145 Introduction... 145 Employees versus Independent Contractors... 145 Tax Deductions for Employee Pay and Benefits... 147 Employee Pay... 147 iv

Payroll Taxes... 149 State Payroll Taxes... 150 Employee Fringe Benefits... 151 Reimbursing Employees for Business-Related Expenditures... 152 Accountable Plans... 153 Unaccountable Plans... 154 Unreimbursed Employee Expenses... 155 Employing Your Family or Yourself... 156 Employing Your Children... 156 Employing Your Spouse... 158 Rules to Follow When Employing Your Family... 158 Employing Yourself... 160 Tax Deductions When You Hire Independent Contractors... 161 No Deductions for ICs Taxes... 161 Paying Independent Contractors Expenses... 162 Review Questions... 163 Review Answers... 165 Chapter 12 What If You Get Sick? Deducting Medical Expenses... 166 Learning Objectives... 166 Introduction... 166 The Health Care Reform Act ( Obamacare )... 166 Health Insurance Mandate... 167 Exemptions From the Mandate... 167 Tax Penalty for Noncompliance... 167 The Employer Mandate... 168 What Is Required Under the New Law... 168 State Health Insurance Exchanges... 169 Health Insurance Premium Tax Credits... 169 The Personal Deduction for Medical Expenses... 171 Deducting Health Insurance Premiums... 172 Personal Income Tax Deduction for the Self-Employed... 172 Deducting Health Insurance as a Business Expense... 173 Tax Credits for Employee Health Insurance... 176 Health Reimbursement Arrangements... 176 What Is a Health Reimbursement Arrangement??... 176 Impact of Obamacare on HRAs... 177 What Expenses May Be Reimbursed?... 178 How to Establish an HRA... 178 Sample HRA... 178 Complying with Annual Reporting and Fee Requirements... 180 Health Savings Accounts... 181 What Are Health Savings Accounts?... 181 Establishing Your HSA... 181 Making Contributions to Your HSA... 183 Withdrawing HSA Funds... 184 Are HSAs a Good Deal?... 185 HSAs for Employees... 185 Tax Reporting for HSAs... 186 Review Questions... 187 Review Answers... 188 Chapter 13 Deductions That Can Help You Retire... 189 Learning Objectives... 189 Introduction... 189 Why You Need a Retirement Plan (or Plans)... 189 Tax Deduction... 190 v

Tax Deferral... 190 Individual Retirement Accounts (IRAs)... 192 Traditional IRAs... 193 Roth IRAs... 193 Employer IRAs... 194 SEP-IRAs... 194 SIMPLE IRAs... 195 Keogh Plans... 195 Types of Keogh Plans... 195 Setting Up a Keogh Plan... 196 Withdrawing Your Money... 196 Solo 401(k) Plans... 196 Review Questions... 198 Review Answers... 199 Chapter 14 More Home Business Deductions... 200 Learning Objectives... 200 Introduction... 200 Advertising... 200 Goodwill Advertising... 200 Giveaway Items... 201 Website Development and Maintenance... 201 Business Bad Debts... 201 Requirements to Deduct Bad Debts... 201 Types of Bad Debts... 203 Casualty Losses... 204 Amount of Deduction... 205 Damage to Your Home Office... 206 Tax Reporting... 206 Charitable Contributions... 206 Dues and Subscriptions... 207 Education Expenses... 207 Starting a New Business... 208 Minimum Educational Requirements... 208 Traveling for Education... 208 Gifts... 209 Insurance for Your Business... 209 Homeowner s Insurance for Your Home Office... 210 Car Insurance... 210 Interest on Business Loans... 210 Home Offices... 211 Car Loans... 211 Loans from Relatives and Friends... 211 Loans to Buy a Business... 211 Interest You Can t Deduct... 211 Deducting Investment Interest... 212 Keeping Track of Borrowed Money... 212 Legal and Professional Services... 213 Buying Long-Term Property... 213 Starting a Business... 213 Accounting Fees... 214 Taxes and Licenses... 214 Income Taxes... 214 Self-Employment Taxes... 214 Employment Taxes... 214 Sales Taxes... 215 Real Property Taxes... 215 vi

Other Taxes... 216 License Fees... 216 Review Questions... 217 Review Answers... 218 Chapter 15 Record Keeping and Accounting... 219 Learning Objectives... 219 Introduction... 219 What Records Do You Need?... 219 Business Checkbook and Credit Cards... 219 Records of Your Income and Expenses... 222 Paper Versus Electronic Records... 222 Create Your Own Spreadsheet... 223 Personal Finance Software... 223 Small Business Accounting Software... 223 Online Bookkeeping... 223 Tracking Your Business Expenses... 224 Supporting Documents... 225 Records Required for Specific Expenses... 228 Automobile Mileage and Expense Records... 228 Entertainment, Meal, Travel, and Gift Expenses... 231 Listed Property... 234 How Long to Keep Records... 235 What If You Don t Have Proper Tax Records?... 236 Accounting Methods... 237 Cash Method... 237 Accrual Method... 239 Which Is Better Accrual or Cash Method Accounting?... 240 Tax Years... 241 Review Questions... 242 Review Answers... 243 Chapter 16 Husband and Wife Home Business... 244 Learning Objectives... 244 Introduction... 244 An Employer-Employee Arrangement... 244 Social Security Tax Savings... 244 Bona Fide Employee Requirement... 245 Reasonable Compensation Requirement... 245 Your Spouse Won t Qualify For Social Security? So What!... 245 What about Limited Liability?... 246 Establish a Qualified Joint Venture... 246 Qualifying for QJV Status... 246 Community Property Sole Proprietorships... 246 Form a Business Entity... 247 Do Nothing... 247 Review Questions... 248 Review Answers... 249 Chapter 17 Staying out of Trouble with the IRS... 250 Learning Objectives... 250 Introduction... 250 What Every Home Business Owner Needs to Know about the IRS... 250 Anatomy of an Audit... 250 The IRS: Clear and Present Danger or Phantom Menace?... 251 You Are the IRS s Number One Target... 252 How Tax Returns Are Selected for Audits... 252 vii

Ten Tips for Avoiding an Audit... 254 Tip #1: Be Neat, Thorough, and Exact... 254 Tip #2: Mail Your Return by Certified Mail... 254 Tip #3: Don t File Early... 254 Tip #4: Don t File Electronically... 254 Tip #5: Form a Business Entity... 255 Tip #6: Explain Items the IRS Will Question... 255 Tip #7: Avoid Ambiguous or General Expenses... 255 Tip #8: Report All of Your Income... 255 Tip #9: Watch Your Income-to-Deduction Ratio... 255 Tip #10: Beware of Abnormally Large Deductions... 256 Review Questions... 257 Review Answers... 258 Chapter 18 Help Beyond This Book... 259 Learning Objectives... 259 Introduction... 259 Secondary Sources of Tax Information... 259 Information From the IRS... 259 Other Online Tax Resources... 261 Tax Publications... 261 Tax Software... 263 The Tax Law... 263 Internal Revenue Code... 263 IRS Regulations... 264 Court Cases... 264 IRS Rulings, Interpretations, and Tax Advice... 265 Review Questions... 267 Review Answers... 268 Glossary... 269 Index... 273 viii