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Home | Thinking About Starting a Business? Consider These Ten Tax Tips

As the end of the year is fast approaching and 2017 will be here soon, if you’ve been thinking about starting a new business, keep in mind that once you are self-employed, a huge portion of the tax code opens up and becomes available to you for tax write-offs.  Of course there are a lot of risks and rewards of starting your own business, but one of those rewards is the availability to take tax write-offs that you wouldn’t otherwise be able to take including dining, travel expenses, and entertainment.  Here are a few tax tips to give you an “eye in the sky” perspective of the tax landscape as you consider if and/or when you will start that new business:

  1. Keep Your Day Job (If You Want To). You can keep your day job / “9 to 5” career while you build your business on the side AND still take all of the tax write-offs that are available to someone who is building their business full-time.  For example, if you leave your day job for the day and meet a potential client of your part-time/side business for dinner that night, you can write-off 50% of that meal JUST LIKE the business owner sitting next to you who runs his business FULL-TIME and is likewise meeting with a potential client for dinner. It’s probably wise in terms of your budget to keep your day job while you start your business but I’m simply pointing out that you have full access to the tax code for business write-offs the same as the guy who is running his business full-time.
  1. Take a Tax Write-off for Business Start-up Costs. The IRS allows up to $5,000 of qualified “start-up expenses” as a tax deduction in the year the costs were incurred.  If you have more than $5,000 of qualifying start-up expenses then the rest is amortized / spread out over a fifteen year period.  For example, if you spend $7,000 of qualified start-up expenses in the year your business began then you can claim a write-off in that first year in the amount of $5,000 and the remaining $2,000 is spread out over 15 years.  If your business closes down prior to that, you can claim the rest as a deduction at that time. HOWEVER, you need to make a sale or receive income in your business in order to write off these start-up costs.  For example, if you had $8,000 of qualified start-up expenses in 2016 but you have no income from your business for 2016, you can’t write-off $5,000 of that for tax year 2016 – You need to have income for your business in 2016 in order to claim that $5,000 deduction for that year. ADDITIONALLY, not every expense qualifies as a “start-up expense”; however,  many expenses DO qualify such as consulting fees and fees for similar professional services, costs to organize your business, cost of travel to meet with potential customers, suppliers, distributers, etc., advertising costs to announce your business opening, and costs to analyze the market/industry in which your business will compete.  IRS Publication 535.  As a practical matter, once your business has received income, expenses after that are no longer “start-up” expenses and are analyzed under Tip #3 below. There are some other rules and caveats regarding start-up expenses but in sum, this is a powerful incentive to get your business started now!
  1. Understand Which Expenses are Tax-Deductible. With some exception, as a general rule, any business expense that is ORDINARY and NECESSARY is tax deductible, i.e., it’s a tax write-off.  The IRS has stated that the word “ordinary” means common and accepted in the industry of your business and the word “necessary” means helpful and appropriate to your business.  For example, if your business sells products online and it is common and accepted in your industry to pay advertising fees and such fees are helpful and appropriate to your business, you can write-off those fees as a tax deduction.  There are many deductions which need to be analyzed further particularly those in which the IRS has set forth specific rules and guidelines such as the home office deduction and the auto deduction but this gives you the general idea of what expenses are typically going to be tax-deductible and which are not.
  1. Keep Good Records. Good record-keeping is the key to claiming tax deductions.  You need to have records that substantiate the tax deductions that you claim on your tax return.  This includes receipts and bank statements as well as good book-keeping using a chart of accounts to track each item of income and expense.  A chart of accounts is also helpful for tracking your business assets and liabilities, which can then generate balance sheets, profit and loss statements, and other financial statements that may help with qualifying for loans, etc.  Quick Books or similar software can help with this.  If organization and record-keeping is not a strength of yours but you are otherwise very entrepreneurial and have many other skill sets to run your business, you may find it helpful to outsource some of these tasks.
  1. Most Tax Deductions are Entity-Agnostic. Almost all of the tax deductions that we discuss for the typical small business owner are available to claim as a tax write-off REGARDLESS of whether your business is a sole proprietorship, LLC, s-corporation, partnership, etc.  For example, with some exception, you can take advantage of many, if not, all of that low hanging fruit such as dining, travel expenses, entertainment, retirement plan contributions, paying kids in your business, health care expenses, home office, etc. and you can be a sole proprietor, an LLC, an s-corporation, etc., it generally does not matter!
  1. Don’t Let the Tax Tail Wag the Dog (Your Business). Be smart about what you purchase in your business.  Simply because an expense is tax-deductible doesn’t mean you should buy it.  Don’t let the tax tail wag the dog, i.e., make the decision to buy business related expenses based on the needs and circumstances of your business.  For example, even if you can deduct that very expensive laptop that might not be the best use of your business capital whereas it could be spent somewhere else in your business much more efficiently and a moderately priced laptop could be sufficient for your business needs.
  1. Some Business Expenses Must be Spread Over Multiple Years. When you purchase an asset in your business you generally cannot claim a deduction for the full cost of the asset in the year of purchase – rather, the cost generally determines the basis meaning when you sell the asset you only pay income tax on the sales price minus the basis.  Further, the cost is generally spread out over multiple years and allows you to claim a portion of the cost each year as a tax deduction, i.e., depreciation. For example, if you purchase office furniture for $8,000 – the cost is generally spread out over seven years (IRS Form 4562).  However, IRS Code Section 179 would allow you to make an election to write-off the full cost in the year of purchase.  Section 179 is a powerful tool for the small business owner!
  1. Consider an accountant/CPA. Once you begin working for yourself, even if only part-time, it pays off to hire an accountant/CPA to do your taxes.  It also pays off to get some training on bookkeeping using software like Quick Books or at least until you’re knowledgeable it may be wise to outsource that task to a competent bookkeeper.  Also, you probably primarily think of federal income tax – don’t forget state income tax, as well as self-employment tax, payroll tax, as well as potentially excise tax, franchise taxes, etc.  All the more reason to consider an accountant/CPA.
  1. There isn’t a legitimate “Pay No Tax Quick” Scheme.  Just like Get-Rich Quick Schemes are usually too good to be true, similarly, the “tax game” is one in which the winner is the one who is steady, aggressive (not too aggressive – remember pigs get fat but hogs get slaughtered), and utilizes sound strategies over the course of many years.
  1. Understand the Type of Income Generally Determines How It is Taxed. Income you make in your business (after subtracting all those tax deductions) is generally included with your other income such as W-2 income to determine what personal income tax bracket you’re in.  But not all income is taxed in the same manner.  For example, income you make in your business is generally subject to self-employment tax whereas other type of income, such as rental income, dividends, and capital gain income is not.  The more you understand how various types of income is taxed then you can learn to be strategic with how you spend your time pursuing some types of income over others.  This where your business can ultimately build wealth for you and your loved ones for many years.

There are many other tips I could give a potential new business owner including the hobby loss rule as well as specific rules regarding home office deductions, auto deductions, Rule 179 deductions, health care deductions, and self-employment tax savings, etc., but these Tips hopefully give a baseline starting point to consider.  Note: many specific tips on various tax deductions can be found at www.markjkohler.com and www.kkoslawyers.com.  If you need assistance with business and tax planning, please call our office at 602-761-9798.

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