Deductions your small business shouldn't miss

Concrete Construction, Dec, 2002 by Shauna Roche

Keep an eye out for those often overlooked ways to cut your tax bill.

It's very simple: the more tax deductions your business can legitimately take, the lower its taxable profit will be. And in addition to putting more money in your pocket at the end of the year, the tax code provisions that govern deductions may also yield a personal benefit: a nice car to drive at a small cost, or a combination business trip and vacation. It all depends on paying careful attention to IRS rules on just what is, and isn't, deductible.

When you're toting up your business expenses at the end of the year, don't overlook these 12 common business deductions.

1. Auto expenses

Operating a car is expensive. The good news is that if you use your car for business, or your business owns its own vehicle, you can deduct some of the costs of keeping it on the road. Mastering the rules of car expense deductions can be tricky but well worth your while. There are two methods of claiming expenses: you can either keep track and deduct your actual business related expenses, or deduct 36.5 cents (2002) for each business mile driven. As a rule, if you use a newer car primarily for business, the actual expense method provides a larger deduction at tax time.

If your auto is used for both business and pleasure, only the business portion produces a tax deduction. That means you must keep track of just how the vehicle is used, and add it all up at the end of the year. Certainly, if you own just one car or truck, no IRS auditor will let you get away with claiming that 100 percent of its use is business related.

2. Expenses of going into business

Once you are running a business, expenses such as advertising, utilities, office supplies, and repairs can be deducted as business expenses. But expenses incurred before you open your doors for business are not deductible. The costs of getting a business started are capital expenses, which must be deducted over the first 5 years you are in business.

Tip: If you expect your business to make a profit immediately, you may be able to work around this rule by delaying paying some bills until after you are in business, or by doing a small amount of business just to get officially started. But if, like many businesses, you will suffer losses the first few years of operation, you might be better off taking the deduction over 5 years, so you'll have some profits to offset.

3. Education expenses

You can deduct education expenses if they are related to your current business, trade, or occupation, but you must follow strict rules. The expense must be to maintain or improve skills required in your present employment or be required by your employer, or be a legal requirement of your job. The cost of education that qualifies you for a new job isn't deductible.

4. Legal and professional fees

Fees you pay lawyers, tax professionals, or consultants generally can be deducted in the year incurred. But if the work clearly relates to future years, they must be deducted over the life of the benefit.

5. Bad debts

If someone stiffs your business, the bad debt may or may not be deductible--it depends on the kind of product you business sells.

If your business sells goods, you can deduct the cost of goods that you sell but aren't paid for.

If, however, your business provides services, no deduction is allowed for the time you devoted to the client or customer who doesn't pay. The rationale behind this rule is that it would be too easy for businesses to inflate bills and claim large deductions for bad debts.

6. Business entertaining

If you pick up the tab for entertaining present or prospective customers, you may deduct 50 percent of the cost if it is either "directly related" to the business, and business is discussed--for example, a catered meeting at your office; or "associated with" the business, and the entertainment takes place immediately before or after a business discussion.

Tip: On the receipt or bill, always make a note of the specific business purpose--for example, "lunch with Joyce Slater of Ace Manufacturing Company to discuss widget contract."

7. Travel

When you travel for business, you can deduct many expenses, including the cost of plane fare, costs of operating a car, taxis, lodging, meals, shipping business materials, clothes cleaning, telephone calls, faxes and tips.

What about combining business and pleasure? It's OK as long as business is the primary purpose of the trip. But if you take your family along, you can deduct only your expenses, just as if you had traveled alone.

8. Interest

If, like many folks, you use credit to finance business purchases, interest and carrying charges are fully tax deductible. The same is true if you take out a personal loan and use the proceeds for your business. But be sure to keep good records showing that the money was really put into your business. Otherwise, if you're audited later, the interest expense deduction could be disallowed because it's considered a personal expense

9. Software

As a general rule, software bought for business use must be depreciated over a 36-month period. But there are three important exceptions: