Small Business Tax Deductions 13 th Edition Stephen Fishman, J.D.
Chapter 1 Tax Deduction Basics... 1 Learning Objectives... 1 Introduction... 1 How Tax Deductions Work... 1 Types of Tax Deductions... 1 You Only Pay Taxes on Your Business Profits... 2 You Must Have a Legal Basis for Your Deductions... 2 You Must Be in Business to Claim Business Deductions... 2 How Businesses Are Taxed... 2 Basic Business Forms... 3 Tax Treatment... 3 Spouses Who Co-Own a Business... 5 The Value of a Tax Deduction... 6 Federal and State Income Taxes... 6 Self-Employment Taxes... 7 Total Tax Savings... 8 What Businesses Can Deduct... 8 Start-Up Expenses... 9 Operating Expenses... 9 Capital Expenses... 9 Inventory... 10 Businesses That Lose Money... 11 Figuring a Net Operating Loss... 11 Carrying a Loss Back... 11 Carrying a Loss Forward... 12 Review Questions... 13 Review Answers... 14 Chapter 2 Are You Really in Business?... 15 Learning Objectives... 15 Introduction... 15 What Is a Business?... 15 Profit Test... 16 Behavior Test... 16 Tax Consequences of Being a Hobbyist... 19 Income-Producing Activities... 20 Tax Consequences of Income-Producing Activities... 20 Types of Income-Producing Activities... 22 Professional Trading in Stocks... 22 Real Estate as a Business... 23 Review Questions... 25 Review Answers... 26 Chapter 3 Start-Up Expenses... 27 Learning Objectives... 27 Introduction... 27 What Are Start-Up Expenses?... 27 Starting a New Business... 28 Common Start-Up Expenses... 28 Costs That Are Not Start-Up Expenses... 28 Buying an Existing Business... 29 Expanding an Existing Business... 30 When Does a Business Begin?... 30 Retail Businesses... 30
Manufacturers... 30 Knowledge Workers... 30 Service Providers... 31 An Existing Business... 31 Claiming the Deduction... 31 If Your Business Doesn t Last 15 Years... 32 Expenses for Businesses That Never Begin... 32 General Start-Up Costs... 32 Organizational Expenses... 33 Avoiding the Start-Up Tax Rule s Bite... 34 Review Questions... 35 Review Answers... 36 Chapter 4 Business Operating Expenses... 37 Learning Objectives... 37 Introduction... 37 Requirements for Deducting Operating Expenses... 37 Ordinary and Necessary... 37 Current Expense... 39 Business-Related... 40 Reasonable... 41 Operating Expenses That Are Not Deductible... 42 Tax Reporting... 43 Review Questions... 44 Review Answers... 45 Chapter 5 Deducting Long-Term Assets... 47 Learning Objectives... 47 Introduction... 47 What Is a Long-Term Asset?... 47 Repairs Versus Improvements: The New IRS Regulations... 48 Routine Maintenance Safe Harbor... 49 Real Property Improvements... 50 How Do the Rules Affect Prior Years?... 50 Methods for Deducting Business Assets... 51 Deducting Inexpensive Property... 52 The De Minimis Safe Harbor... 52 The Materials and Supplies Deduction... 55 Rules for Deducting Any Long-Term Asset... 55 What Property Is Eligible... 55 Real Versus Personal Property... 56 Mixed-Use Property... 56 Listed Property... 57 When Depreciation Starts and Ends... 57 How Much You Can Deduct... 57 Disposing of Long-Term Assets... 58 Section 179... 59 Property You Can Deduct... 59 Calculating Your Deduction... 61 Recapture Under Section 179... 63 Bonus Depreciation... 64 How It Works... 64 Property that Qualifies for Bonus Depreciation... 64 Placed In Service Date... 65 Class-Wide Requirement... 65 Calculating the Bonus Amount... 65 Opting Out of the Bonus... 65 ii
Regular Depreciation... 65 When to Use Regular Depreciation... 66 Depreciation Period... 67 First-Year Depreciation... 67 Depreciation Methods... 68 Depreciation Tables... 70 Depreciation Rules for Listed property... 70 Computer Software... 71 Real Property... 71 Intangible Assets... 72 Natural Resources... 72 Depreciation Recapture... 72 Tax Reporting and Record Keeping... 73 Leasing Long-Term Assets... 74 Leasing Versus Purchasing... 74 Leases Versus Installment Purchases... 75 Review Questions... 76 Review Answers... 77 Chapter 6 Inventory... 79 Learning Objectives... 79 Introduction... 79 What Is Inventory?... 79 Supplies Are Not Inventory... 79 Incidental Supplies... 80 Long-Term Assets... 80 Deducting Inventory Costs... 81 Computing the Cost of Goods Sold... 81 IRS Reporting for Cost of Goods Sold... 81 Maintaining an Inventory... 82 When You Provide Services and Sell Merchandise... 82 Supplies for Providing a Service... 83 Determining the Value of Inventory... 83 Taking Physical Inventory... 83 Identifying Inventory Items Sold During the Year... 84 Valuing Your Inventory... 84 Review Questions... 86 Review Answers... 87 Chapter 7 Office Expenses... 89 Learning Objectives... 89 Introduction... 89 Qualifying for the Home Office Deduction... 89 Threshold Requirement: Regular and Exclusive Business Use... 90 Additional Requirements... 93 Storing Inventory or Product Samples at Home... 96 Corporation Employees... 96 Calculating the Home Office Deduction... 97 How Much of Your Home Is Used for Business?... 97 What Expenses Can You Deduct?... 99 Simplified Home Office Deduction Method... 104 How the Simple Method Works... 104 Is the Simplified Method a Good Deal?... 105 IRS Reporting Requirements... 105 Sole Proprietors... 105 LLCs and Partnerships... 106 Corporations... 106 iii
Filing 1099-MISCs... 106 Audit-Proofing Your Home Office Deduction... 106 Show You re Following the Rules... 107 Keep Good Expense Records... 107 Deducting an Outside Office or Workplace... 107 Renting an Outside Workplace... 107 Buying an Outside Workplace... 110 Review Questions... 111 Review Answers... 112 Chapter 8 Car and Local Travel Expenses... 113 Learning Objectives... 113 Introduction... 113 Deductible Local Transportation Expenses... 113 Travel Must Be for Business... 113 Commuting Is Not Deductible... 114 The Standard Mileage Rate... 119 How the Standard Mileage Rate Works... 119 Requirements to Use the Standard Mileage Rate... 120 The Actual Expense Method... 121 How the Actual Expense Method Works... 121 Record-Keeping Requirements... 122 Vehicle Depreciation Deductions... 122 Leasing a Car... 127 How to Maximize Your Car Expense Deduction... 128 Use the Method That Gives the Largest Deduction... 128 Keep Good Records... 128 Other Local Transportation Expenses... 128 When Clients or Customers Reimburse You... 128 Reporting Transportation Expenses on Schedule C... 129 Corporations, LLCs, and Partnerships... 130 Using Your Own Car... 130 Using a Company Car... 131 Review Questions... 133 Review Answers... 134 Chapter 9 Business Travel... 137 Learning Objectives... 137 Introduction... 137 What Is Business Travel?... 137 Where Is Your Tax Home?... 138 Your Trip Must Be for Business... 140 What Travel Expenses Are Deductible... 141 Traveling First Class or Steerage... 142 Taking People With You... 142 How Much You Can Deduct... 143 Travel Within the United States... 143 Travel Outside the United States... 144 Conventions... 145 Travel by Ship... 146 Calculating Time Spent on Business... 146 50% Limit on Meal Expenses... 147 Maximizing Your Business Travel Deductions... 148 Plan Ahead... 148 Make a Paper Trail... 149 Maximize Your Business Days... 149 Take Advantage of the Sandwich Day Rule... 149 iv
How to Deduct Travel Expenses... 149 Sole Proprietors... 150 Partnerships and LLCs... 150 Corporations... 150 Travel Expenses Reimbursed by Clients or Customers... 151 Review Questions... 152 Review Answers... 153 Chapter 10 Meal and Entertainment Expenses... 155 Learning Objectives... 155 Introduction... 155 What Is Business Entertainment?... 155 Activities That Aren t Entertainment... 155 Meals Can Be Travel or Entertainment... 156 Who You Can Entertain... 156 Deducting Entertainment Expenses... 156 Business Discussions Before or After Entertainment... 157 Business Discussions During Meals... 157 Entertaining at Home... 158 Entertainment in Clear Business Settings... 158 Calculating Your Deduction... 159 Expenses Must Be Reasonable... 159 Going Dutch... 159 Expenses You Can t Deduct... 159 Entertainment Tickets... 160 Reimbursed Expenses... 161 Meals for Employees... 161 Reporting Entertainment Expenses on Your Tax Return... 162 Sole Proprietors... 162 Partnerships, LLCs, and LLPs... 162 Corporations... 162 Review Questions... 163 Review Answers... 164 Chapter 11 Hiring Workers... 165 Learning Objectives... 165 Introduction... 165 Employees Versus Independent Contractors... 165 Tax Deductions for Employee Pay and Benefits... 167 Employee Pay... 167 Payroll Taxes... 169 Employee Fringe Benefits... 171 Reimbursing Employees for Business-Related Expenditures... 172 Accountable Plans... 172 Unaccountable Plans... 174 Unreimbursed Employee Expenses... 174 Employing Your Family or Yourself... 175 Employing Your Children... 175 Employing Your Spouse... 177 Rules to Follow When Employing Your Family... 178 Employing Yourself... 180 Tax Deductions When You Hire Independent Contractors... 181 No Deductions for IC s Taxes... 182 Paying Independent Contractors Expenses... 182 Review Questions... 184 Review Answers... 185 v
Chapter 12 Retirement Deductions... 187 Learning Objectives... 187 Introduction... 187 Why You Need a Retirement Plan (or Plans)... 187 Tax Deduction... 188 Tax Deferral... 188 Individual Retirement Accounts IRAs... 190 Traditional IRAs... 191 Roth IRAs... 191 Employer IRAs... 192 SEP-IRAs... 192 SIMPLE IRAs... 193 Keogh Plans... 193 Types of Keogh Plans... 193 Setting Up a Keogh Plan... 194 Solo 401(k) Plans... 194 Review Questions... 196 Review Answers... 197 Chapter 13 Medical Expenses... 199 Learning Objectives... 199 Introduction... 199 The Affordable Care Act (Obamacare)... 199 Health Insurance Mandate... 200 Obamacare Health Insurance Rules... 202 State Health Insurance Exchanges... 202 Open Enrollment Periods... 203 Health Insurance Premium Assistance Credits... 204 The Personal Deduction for Medical Expenses... 205 Deducting Health Insurance Costs... 206 Personal Income Tax Deduction for the Self-Employed... 206 Deducting Health Insurance as a Business Expense... 207 Tax Credits for Employee Health Insurance... 210 Requirement #1: You Must Have Employees... 211 Requirement #2: Employee Compensation Must Average Less Than $51,800... 211 Requirement #3: You Must Obtain Health Insurance through State SHOP Exchange... 211 Requirement #4: You Must Pay at Least 50% of Employee Health Insurance Premiums... 212 Amount of the Credit... 212 Adopting a Health Reimbursement Arrangement... 212 What Is a Health Reimbursement Arrangement?... 212 Impact of Obamacare on HRAs... 214 What Expenses May Be Reimbursed?... 215 How to Establish an HRA... 216 Sample HRA... 216 Complying with Annual Reporting and Fee Requirements... 216 Health Savings Accounts... 216 What Are Health Savings Accounts?... 216 Establishing Your HSA... 217 Making Contributions to Your HSA... 218 Deducting HSA Contributions... 219 Withdrawing HSA Funds... 220 Are HSAs a Good Deal?... 220 HSAs for Employees... 221 Tax Reporting for HSAs... 222 Review Questions... 223 Review Answers... 224 vi
Chapter 14 Additional Deductions... 225 Learning Objectives... 225 Introduction... 225 Advertising... 225 Goodwill Advertising... 225 Giveaway Items... 226 Website Development and Maintenance... 226 Permanent Signs... 226 Business Bad Debts... 227 Three Requirements to Deduct Bad Debts... 227 Types of Bad Debts... 228 Casualty Losses... 230 Amount of Deduction... 230 Damage to Your Home Office... 231 Tax Reporting... 231 Charitable Contributions... 232 Contributions by Proprietors, LLCs, Partnerships, and S Corporations... 232 Clothing... 232 Dues and Subscriptions... 233 Education Expenses... 233 Starting a New Business... 234 Minimum Educational Requirements... 234 Traveling for Education... 234 Gifts... 235 Insurance for Your Business... 235 Homeowners Insurance for Your Home Office... 235 Car Insurance... 236 Interest on Business Loans... 236 Home Offices... 236 Car Loans... 236 Loans to Buy a Business... 237 Loans From Relatives and Friends... 237 Interest You Can t Deduct... 237 Deducting Investment Interest... 237 Keeping Track of Borrowed Money... 238 Legal and Professional Services... 239 Buying Long-Term Property... 239 Starting a Business... 239 Accounting Fees... 239 Taxes and Licenses... 239 Income Taxes... 239 Self-Employment Taxes... 239 Employment Taxes... 240 Sales Taxes... 240 Real Property Taxes... 240 Other Taxes... 241 License Fees... 241 Domestic Production Activities... 241 Activities That Qualify for the Deduction... 241 Excluded Activities... 242 Tangible Personal Property Mixed With Services... 243 Amount of Deduction... 243 Limits on the Deduction... 243 Review Questions... 244 Review Answers... 245 vii
Chapter 15 Record Keeping and Accounting... 247 Learning Objectives... 247 Introduction... 247 What Records Do You Need?... 247 Business Checkbook and Credit Cards... 247 Calendar or Appointment Book... 249 Records of Your Business Income and Expenses... 250 Tracking Your Business Expenses... 252 Supporting Documents... 253 Records Required for Specific Expenses... 256 Automobile Mileage and Expense Records... 256 Entertainment, Meal, Travel, and Gift Expenses... 259 Listed Property... 261 How Long to Keep Records... 262 What If You Don t Have Proper Tax Records?... 263 Accounting Methods... 263 Cash Method... 264 Accrual Method... 265 Which Is Better: Accrual or Cash Method Accounting?... 266 Tax Years... 267 Review Questions... 268 Review Answers... 269 Chapter 16 Claiming Tax Deductions for Prior Years... 271 Learning Objectives... 271 Introduction... 271 Reasons for Amending Your Tax Return... 271 Net Operating Losses... 271 Retroactive Tax Laws... 272 Casualty Losses... 272 Time Limits for Filing Amended Returns... 272 Three-Year Amendment Period... 272 Section 179 Deductions... 273 Net Operating Losses... 273 Bad Debts... 273 Business Start-Up Expenses... 273 How to Amend Your Return... 273 How the IRS Processes Refund Claims... 274 Review Questions... 275 Review Answers... 276 Chapter 17 Staying Out of Trouble with the IRS... 277 Learning Objectives... 277 Introduction... 277 What Every Business Owner Needs to Know About the IRS... 277 Anatomy of an Audit... 277 The IRS: Clear and Present Danger or Phantom Menace?... 278 You Are a Prime IRS Target... 279 How Tax Returns Are Selected for Audits... 279 Eight Tips for Avoiding an Audit... 281 Tip #1: Be Neat, Thorough, and Exact... 281 Tip #2: Don t File Early... 281 Tip #3: Form a Business Entity... 281 Tip #4: Explain Items the IRS Will Question... 281 Tip #5: Avoid Ambiguous or General Expenses... 282 Tip #6: Report All of Your Income... 282 Tip #7: Watch Your Income-to-Deduction Ratio... 282 viii
Tip #8: Beware of Abnormally Large Deductions... 282 Review Questions... 283 Review Answers... 284 Chapter 18 Help Beyond This Book... 285 Learning Objectives... 285 Introduction... 285 Secondary Sources of Tax Information... 285 Information From the IRS... 285 Other Online Tax Resources... 286 Tax Publications... 287 Tax Software... 288 The Tax Law... 289 Internal Revenue Code... 289 IRS Regulations... 290 Court Cases... 290 IRS Rulings, Interpretations, and Tax Advice... 291 Consulting a Tax Professional... 292 Types of Tax Pros... 292 Review Questions... 294 Review Answers... 295 Glossary... 297 Index... 301 ix