Festival Network Online News Letter
March - 2002
After Diane Bruckner's Dianebruckner@aol.com great article last month on keeping your creativity flowing, Diane has agreeded to stay on as our Newsletter Editor. This month she has found a timely piece by James Dillehay on taxes. Enjoy! (well as much as you can, we are talking about taxes...!)
Our Feature Article for this month:
Tax Advantages for the Self-Employed
by James Dillehay
Deducting start-up costs:
If you're self-employed, when you begin your business, you spend money on expenses that the IRS calls "start-up" costs. There are only two ways to deduct these costs. One is that you capitalize the costs and get the deduction when you quit or sell your business. In general, this is undesirable because how many crafters will actually sell their business? The other way start-up costs can be deducted is to amortize or spread out the deductions over five years. But you must choose to do this in the start-up year. It is important in the beginning of your business to make the right choice. If you do not make the correct choice, you may lose your deductions. For instance, say you spent $7,000 on equipment, tools, furniture, travel, and rent to start-up your business which as of yet does not exist. You deduct these expenses from your income as normal business expenses. The IRS disallows your deductions because the business did not exist when you put that money out. By this time, you are into the next tax year. You lose the chance to amortize and must now wait until you sell or quit the business. To get your deduction, choose to amortize these costs in the tax year during which the active business starts. Consult an accountant. Start-up costs are any money paid to create an active business and any expenses that would normally be deductible if there were an existing business. Examples include travel, entertainment, hiring consultants, advertising, training, finding suppliers, finding buyers, getting professional accounting advice, tools, and so on.
Keep a business journal:
Use a daily planner or appointment book and record your business activities every day. Keep receipts for all expenses and sales, canceled checks, credit card charge slips, letters, photographs, and any additional evidence to support your claims. The way the tax law reads, it is a requirement to keep a diary of daily tasks to prove business activity. In 1995, it became tax law that you are not required to keep receipts for business travel and entertainment expenses less than $75 while out of town. As for other receipts, keep them all. Canceled checks are not enough alone, as you have to produce documentation to list your expenses. Use a separate credit card for business costs because you get a receipt as proof of payment and you get a monthly statement as proof of payment. If you make a charge for a business expense near the end of the year, it will be deductible in the year charged. A separate charge card for business also allows you to track business interest payments which is deductible. Some of the documentation proofs that may safeguard you from an audit include an appointment book, a business customer list, a daily log of receipts, journal of expenses and income, deposit slips, bank statements, and canceled checks. Another tip, make sure your receipts match your claims. An auditor can check your motel receipts to show how many people occupied the room.
Home office deductions:
You can use many structures for your home office business. Examples include a house, apartment, condo, mobile home, or boat. You can also include structures on your property like a separate garage, studio, barn, or greenhouse. The home office deduction is probably worth about $1,000 in deductions for each $100,000 in home worth. The IRS considers your home office as your principal place of business when you:
Use it for performing the important functions of your business.
Collect money from customers in it.
Spend more time in the home office than at other work locations.
You can deduct expenses for a separate structure like a studio or garage if the building is used exclusively for the business. In this case, the building does not have to be the principal place of business or a place where you meet customers. You can also expense property or assets used for your business in your home, even if you don't qualify for the home office deduction. For instance, you buy a new work table that costs $500. Your home business does not qualify you for home office deduction because you use the room only 75% for the business (you must use the room 100% for business to qualify). You can expense $375 of the table or 75% of $500. You are allowed to deduct up to $17,500 of the cost of new or used office equipment, tools and other qualifying personal property bought in the same tax year. You must use the property 100% for business or you can only deduct the percentage of business use of the property. Also you can only deduct up to the amount of business income for the same tax year. Any cost chosen to be expensed that is above the limitation of the current year can be carried into the next year. You can deduct indirect expenses like rent, utilities, insurance, security systems, property taxes, deductible mortgage interest, repairs, and depreciation in proportion to your business use of the home. To determine the amount, first find out the total square feet of your home. Then measure the square feet of your home office. Divide the home office footage by the total area of the house. That gives you the percentage to multiply your indirect expenses by. Say you have a 1,600 square foot house and you use one 400 square foot room for business. You use 25% of your home for business and can deduct 25% of the indirect expenses. Remember to keep a journal or diary proving this room is only used for business. Photos with dates stamped by the film developers will be acceptable evidence.
Hire your kids:
If your child is over six years old, the IRS says they may be a real employee. If the child is under eighteen years old, wages parents pay their children are tax exempt. You cannot use your children as employees if your business is a corporation or a partnership, only if you are a sole proprietorship, independent contractor, or an employee. To qualify the deduction must be:
A reasonable amount.
Paid for services actually performed.
Your children's employment must be by the books and you have to prove it with check stubs, receipts, and a diary. You benefit from hiring a child under eighteen, because you can deduct wages, which reduces your income and self-employment taxes, and you and your child are exempt from payroll taxes on wages paid. However, you have to prove that the amount you pay in wages is a normal wage for the particular tasks and not artificially high.
Rent or lease from your spouse:
Since rent is a deductible business expense, you pay Social Security and self-employment taxes on your net business income after you deduct any rent you pay to your spouse. You report rent income (your spouse's) on Schedule E of your tax return where you deduct depreciation. On rental income, you don't pay Social Security or self-employment taxes. When husband and wife are separate taxpayers, rent paid by the husband to the wife, or vice versa, is deductible by the husband and reportable income for the wife, or vice versa. If your business income is under $61,000, for each dollar of rent expense you claim, you will save around 15%. Possible assets you might need in your business you could rent from your spouse include a car, desk, computer, tools, furniture, office equipment, and even office or studio space. The test is, do you really need it in your business and would you rent it from a retail rental agent? To pass an audit for claiming the rent from spouse, you must prove that:
You paid fair market rent for the assets.
You have a written agreement.
Your spouse received payments and deposited them in a separate account.
Your spouse can prove they owned the assets.
You paid state sales tax on the rentals.
The self-employed health deduction allows you to deduct 30% of money spent on health insurance. You would get a much better deal by hiring your spouse and paying medical expenses under an employee health plan. You can then claim 100% of those expenses as a deductible employee expenses on your Schedule C.
A trip from your home to your office or any regular place of business is considered commuting, therefore personal, and not deductible as a business expense. However, you can deduct miles driven between two business locations. So if you have a home office and you drive to a store account, that is legitimate deductible mileage. Recently, standard mileage deductions were around 33 cents per business mile. You can claim the IRS standard mileage or figure all your gas, repairs, tires, oil, insurance, registration fees, and depreciation. You must have adequate records to prove your total miles driven during the tax year.
You can claim travel expenses for your business if you have to spend the night away from home while pursuing business. Even if you spend some time for personal reasons, as long as you spend more days on business than pleasure, deduct 100% of travel expenses. For each day of business travel, deduct lodging costs, and 50% of your meals. If weather or other circumstances prevent you from carrying out your business, you can still deduct the travel expenses. You can deduct travel costs to attend trade shows, training and conventions if business related. If your spouse or children are employed by you, you can deduct their expenses, too. Your travel expense deductions are more credible if you log and record the expenses at the time of purchase. Usually, taxpayers who lose court cases involving travel lacked proper entries in a diary. You should record: Amount you spent on lodging, food, gas, parking, or taxis. Time of day you departed and returned for each trip and number of days away for business. Places you traveled to. Nature of business or purpose of business trip.
For an excellent resource of many more home business deductions, see 422 Tax Deductions by Bernard Kamaroff, C.P.A.
James Dillehay www.craftmarketer.com
© James Dillehay, excerpted with permission from the book
The Basic Guide to Pricing Your Craftwork.
James is a past member of the advisory board to the National Craft Association. No part of this material may be reproduced in any form including electronic.
To order online: www.craftmarketer.com/books.htm
Phone: 800-235-6570 within North America.
Diane Elliott Bruckner
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