Small-business tax rule No. 1: Don't mess with the IRS.
But that doesn't mean you should cheat yourself. Take every legal deduction you can. Here are a dozen that even savvy small-business owners and entrepreneurs sometimes forget.
1. Home office
Concerned that claiming a home office deduction is tantamount to sending an engraved invitation to an IRS auditor? Don't be, says Jan Zobel, author of "Minding Her Own Business: The Self-Employed Woman's Guide to Taxes and Recordkeeping."
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The deductible dozen
- Home office.
- Office supplies.
- Other equipment.
- Software and subscriptions.
- Travel, meals, entertainment and gifts.
- Insurance premiums.
- Retirement contribution.
- Social Security.
- Telephone charges.
- Child labor.
"I don't agree that chances of getting audited are greater with a home office deduction," says Zobel, a San Francisco Bay-area tax expert who specializes in serving the self-employed. The key is that you use the term "home office" the same way the IRS does. The tax agency says it must be a space devoted to your business and absolutely nothing else. Deducting the den that houses the family computer and serves as a guest bedroom won't fly with Uncle Sam.
"If you only have one computer and you have a child over 4, the IRS is going to be pretty certain that the child is using the computer," says Zobel. "And the burden of proof is on you."
The deduction, however, isn't limited to a full room. Your home office can be part of a room. Just how much of the space is deductible? Measure your work area and divide by the square footage of your home. That percentage is the fraction of your home-related business expenses -- rent, mortgage, insurance, electricity, etc. -- that you can claim.
There's also a newer way to claim a home office deduction. Read "Use newer, simplified home office deduction" for details.
2. Office supplies
Even if you don't take the home office deduction, you can deduct the business supplies you buy. Hang on to those receipts, because these expenditures will offset your taxable business income.
When your office supplies are more than just pens and paper, you have another tax-cutting opportunity.
Office-furniture acquisitions provide a couple of choices. Deduct 100% of the cost in the year of the purchase or deduct a portion of the expense over 7 years, also known as depreciation.
To take the whole cost in one tax year, you'll use the Section 179 deduction (named for the part of the tax code where the law appears). Recent tax-law changes have made this deduction even more attractive. The Protecting Americans from Tax Hikes, or PATH, Act enacted in December 2015, made the expensing option a permanent part of the tax code with a $500,000 deduction cap, to be adjusted for inflation each year. A low inflation rate means the 2016 limit stays at half a million.
If you choose instead to depreciate the desks and filing cabinets, you can't simply split the cost into equal portions over the depreciation period. Instead, you must use an IRS chart to make separate calculations each year.
Which is better for you? Anticipate the times that your business will need these deductions the most. Both options are reported on IRS Form 4562.
4. Other equipment
Items such as computers, copiers, fax machines and scanners also are tax-deductible. As with furniture, you can take 100% upfront or depreciate (this time over 5 years).
5. Software and subscriptions
The increased Section 179 provides another tax break in this area of business expenses. Previously, a company had to depreciate the cost of computer software over 3 years. Now, off-the-shelf software a business buys can be fully expensed in the year purchased.
The rules for deducting business and industry-related magazine subscriptions weren't changed. You can continue to take the total costs as a full deduction in the year spent.
If you drive for business, the IRS wants to give you some of your money back. But Uncle Sam loves documentation, so keep a notebook in your vehicle to record the date, mileage, tolls, parking costs and the purpose of your trip.
At the end of the year, you have 2 choices. You can total the mileage and add in the tolls and parking to calculate your deduction. Once you have your mileage total, multiply it by 57.5 cents for your 2015 deduction. For 2016 business tax purposes, the rate drops to 54 cents a mile.
Or you can measure your business usage against your personal driving and deduct that portion of your auto-related expenses, says Zobel. Remember to include gas, repairs and insurance.