Tax Planning for Small Business Owners Amanda Hansen Laura Robins Holly Thomson

Capitalized Cost or Deductible Expense ? Capitalized Cost – “permanent improvements or betterments made to increase the value of any property” IRC §263(a) Deductible Expense – “ordinary and necessary expense paid or incurred during the taxable year in carrying on any trade or business” IRC §162(a)

Definitions Capitalized Costs are recorded as an asset on the balance sheet and depreciated over the useful life “Ordinary” Expense – common and accepted in your field of business “Necessary” Expense – helpful and appropriate for your business

Examples of Capital Expenditures Costs to acquire buildings, machinery and equipment, furniture and fixtures, and similar property. Replacing a roof on a building Additions to a structure Remodeling Landscaping Improvements which add to the value of the building Architect's fees Costs incurred to build it yourself

Examples of Deductible Expenses Business bad debt Car and truck expenses Depreciation Routine repairs and maintenance costs Employee’s pay Interest on business debt Legal and professional fees Contributions to retirements plans Health insurance premiums One-half of self-employment tax State or local personal property tax or registration fees Business travel expenses 50% of meals and entertainment Home office

Examples of Nondeductible Expenses Bribes and kickbacks Demolitions expenses or losses Dues to business, social, athletic, luncheon, sporting, airline, and hotel clubs Lobbying expenses Penalties or fines Political contributions Repairs that add to property value or life

What Property Can Be Depreciated? It must be property you own It must be used in business or held to produce income It must have a useful life that extends substantially beyond the year it is placed in service It must be something that has a determinable useful life It must not be excepted property

Depreciable Lives 3 year:software 5 year:automobiles, computers, 7 year:office furniture and equipment, other property 27.5 year: residential real property 39 year: nonresidential real property

Using Depreciation Tables Depreciation Rate for Recovery Period Year3-Year5-Year7-Year %20.00%14.29% $6,000 x 24.49% = $1,469.40

Section 179 Depreciation Asset cost deducted in year placed in service Tangible personal property used in trade or business Dollar limits: –$24,000 in 2002 –$25,000 in 2003 Reduced dollar limit for costs exceeding $200,000 Recapture if business use drops below 50%

Special Depreciation Allowance Property acquired after Sept. 10, 2001 and before Sept. 11, 2004 Property placed in service after Sept. 10, 2001 and before Jan. 1, 2005 Qualified property –Original use – No real property Additional deduction of 30% of basis

Deducting Health Insurance Premiums Deduct health insurance costs you pay for self, spouse, and dependents –In 2002, 70% expenses deductible –In 2003, 100% expenses deductible Cannot include actual medical expenses Cannot deduct if net loss on Schedule C Can only take deductions for months you and spouse not eligible for employer plan

Deducting Car Expenses If you use your vehicle for both business and personal purposes, you must divide your expenses between business and personal use. You can choose to expense based on a standard mileage rate (36.5 cents/mile) or your actual expenses. Actual expenses is an irrevocable election

Actual Car Expenses DepreciationLease paymentsRegistration Garage rentLicensesRepairs GasOilTires InsuranceParking feesTolls

Daily Business Mileage Expense Log Source - IRS Publication 463: Travel, Entertainment, Gift, and Car Expenses

When are Meals & Entertainment Expenses Deductible? You can deduct ordinary and necessary expenses to entertain a client, customer, or employee if the expenses meet the directly-related test or the associated test Subject to 50% limit

Travel Expenses Must meet two conditions: –Business duties require you to be away for longer than an ordinary days work –You need sleep or rest to meet the demands of your work while away from home

Deductible Travel Expenses Transportation Baggage and shipping Tolls and parking fees Rental car Meals and overnight lodging (subject to 50%)

Home Office Deduction Must use a certain portion of your home both regularly and exclusively for business Your home office must be your principal place of business

Calculating Home Office Deduction Go through your records Determine your office’s share of home expenses Determine direct expenses of the home office Calculate your office’s share of the depreciation on your home Categorize and total your home office expenses Deduction is limited to business net income

Moving Expenses Closely related to start of work –Incurred within 1 year from date began work at new location –New home must be closer than the former home to the new job Time test –Employees: work fulltime 39 weeks during first 12 months in new area –Self-employed: work fulltime same as employees AND for a total of at least 78 weeks during the first 24 months

Distance test – New job is at least 50 miles farther from former home than old job was from former home IRS Publication 521: Moving Expenses

Deductible Moving Expenses Moving household goods and personal effects Traveling (including lodging but not meals) to your new home Must be reasonable Expenses for yourself and members of your family

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