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LAW for ALL EIGHTH EDITION JANUARY 2012 Editor DIANA FITZPATRICK Cover Design & Production SUSAN PUTNEY Proofreading ELAINE MERRILL Index SONGBIRD INDEXING Printing BANG PRINTING International Standard Serial Number (ISSN): 1941-8248 ISBN 978-1-4133-1636-0 (pbk.) — ISBN 978-1-4133-1662-9 (epub e-book) Copyright © 2004, 2005, 2006, 2007, 2008, 2009, 2010, and 2011 by Nolo. All rights reserved.  e NOLO trademark is registered in the U.S. Patent and Trademark Offi ce. Printed in the U.S.A. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without prior written permission. Reproduction prohibitions do not apply to the forms contained in this product when reproduced for personal use. For information on bulk purchases or corporate premium sales, please contact the Special Sales Department. Call 800-955-4775 or write to Nolo, 950 Parker Street, Berkeley, California 94710. Please note We believe accurate, plain-English legal information should help you solve many of your own legal problems. But this text is not a substitute for personalized advice from a knowledgeable lawyer. If you want the help of a trained professional—and we’ll always point out situations in which we think that’s a good idea—consult an attorney licensed to practice in your state. Acknowledgments Many thanks to: Diana Fitzpatrick and Lisa Guerin for their superb editing Terri Hearsh for her outstanding book design About the Author Stephen Fishman is a San Francisco-based attorney and tax expert who has been writing about the law for more than 20 years. He is the author of many do-it-yourself law books, including Home Business Tax Deductions, Every Landlord’s Tax Deduction Guide, and Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Consultants. All of his books are published by Nolo. He is often quoted on tax-related issues by newspapers across the country, including the Chicago Tribune, San Francisco Chronicle, and Cleveland Plain Dealer. Table of Contents Your Tax Deduction Companion 1 1 Tax Deduction Basics 5 How Tax Deductions Work 6 How Businesses Are Taxed 9 e Value of a Tax Deduction 16 What Businesses Can Deduct 20 Businesses at Lose Money 24 2 Are You Really in Business? 29 What Is a Business? 31 Tax Consequences of Being a Hobbyist 38 Income-Producing Activities 40 3 Start-Up Expenses 49 What Are Start-Up Expenses? 50 Starting a New Business 51 Buying an Existing Business 54 Expanding an Existing Business 55 When Does a Business Begin? 56 Claiming the Deduction 59 If Your Business Doesn’t Last 15 Years 60 Expenses for Businesses at Never Begin 61 Organizational Expenses 63 Avoiding the Start-Up Tax Rule’s Bite 64 4 Business Operating Expenses 65 Requirements for Deducting Operating Expenses 66 Operating Expenses at Are Not Deductible 74 Tax Reporting 76 5 Deducting Long-Term Assets 77 What is a Long-Term Asset? 79 Methods for Deducting Business Assets 82 Rules for Deducting Any Long-Term Asset 84 Section 179 90 Bonus Depreciation 101 Regular Depreciation 106 Tax Reporting and Record Keeping 121 Leasing Long-Term Assets 123 6 Inventory 127 What Is Inventory? 128 Deducting Inventory Costs 131 Maintaining an Inventory 134 Determining the Value of Inventory 136 7 Office Expenses 141 Qualifying for the Home Office Deduction 142 Corporation Employees 155 Calculating the Home Office Deduction 157 IRS Reporting Requirements 171 Audit-Proofing Your Home Office Deduction 173 Deducting an Outside Office or Workplace 174 8 Car and Local Travel Expenses 181 Deductible Local Transportation Expenses 182 e Standard Mileage Rate 193 e Actual Expense Method 197 How to Maximize Your Car Expense Deduction 213 Other Local Transportation Expenses 215 When Clients or Customers Reimburse You 215 Reporting Transportation Expenses on Schedule C 216 Corporations, LLCs, and Partnerships 218 9 Business Travel 223 What Is Business Travel? 224 What Travel Expenses Are Deductible 232 How Much You Can Deduct 234 Maximizing Your Business Travel Deductions 247 How to Deduct Travel Expenses 249 Travel Expenses Reimbursed by Clients or Customers 252 10 Meal and Entertainment Expenses 255 What Is Business Entertainment? 256 Who You Can Entertain 258 Deducting Entertainment Expenses 258 Calculating Your Deduction 264 Reporting Entertainment Expenses on Your Tax Return 270 [...]... of Tax Deductions There are three basic types of tax deductions: personal deductions, investment deductions, and business deductions This book covers only business deductions—the large array of write-offs available to business owners Personal Deductions For the most part, your personal, living, and family expenses are not tax deductible For example, you can’t deduct the food that you buy for yourself... 27 6  |  DEduct It! Lower Your Small Business Taxes T he tax code is full of deductions for businesses—from automobile expenses to wages for employees Before you can start taking advantage of these deductions, however, you need a basic understanding of how businesses pay taxes and how tax deductions work This chapter gives you all the information you need to get started It covers: • how tax deductions... You Only Pay Taxes on Your Business Profits 7 You Must Have a Legal Basis for Your Deductions 8 You Must Be in Business to Claim Business Deductions 8 How Businesses Are Taxed 9 Basic Business Forms 9 Tax Treatment 11 Spouses Who Co-Own a Business 14 The Value of a Tax Deduction 16 Federal and State Income Taxes ... tax on every dollar your business takes in (your gross business income) Instead, you owe tax only on the amount left over after your business s deductible expenses are subtracted from your gross income (this remaining amount is called your net profit) Although some tax deduction calculations can get a bit complicated, the basic math is simple: The more deductions you take, the lower your net profit will... or business, any other gain from a passive trade or business, and taxable gains from the sale or other disposition of investment property 20  |  DEduct It! Lower Your Small Business Taxes Total Tax Savings When you add up your savings in federal, state, and self-employment taxes, you can see the true value of a business tax deduction For example, if you’re in the 25% federal income tax bracket, a business. .. 1  |  Tax Deduction Basics  |  19 effective self-employment tax rate is lower, because (1) you are allowed to deduct half of your self-employment taxes from your net income for income tax purposes, and (2) you pay self-employment tax on only 92.35% of your net self-employment income Like income taxes, self-employment taxes are paid on the net profit you earn from a business Thus, deductible business. .. right to take a particular deduction If you are audited by the IRS, however, you’ll have to provide a legal basis for every deduction you take If the IRS concludes that your deduction wasn’t justified, it will deny the deduction and charge you back taxes and, in some cases, penalties You Must Be in Business to Claim Business Deductions Only businesses can claim business tax deductions This probably seems... business deduction can be worth as much as 25% (in federal taxes) + 13.3% (in self-employment taxes) + 6% (in state taxes) That adds up to a whopping 44.3% savings (If you itemize your personal deductions, your actual tax savings from a business deduction are a bit less because the deduction reduces your state income tax and therefore reduces the federal income tax savings from this itemized deduction.)... expenses) are currently deductible— 22  |  DEduct It! Lower Your Small Business Taxes that is, you can deduct them all in the same year when you pay them (See Chapter 4 for more on deducting operating expenses.) Example: After Cary’s salon opens, he begins paying $5,000 a month for rent and utilities This is an operating expense that is currently deductible When Cary does his taxes, he can deduct from his... work • how businesses are taxed • how to calculate the value of a tax deduction, and • what businesses can deduct How Tax Deductions Work A tax deduction (also called a tax write-off) is an amount of money you are entitled to subtract from your gross income (all the money you make) to determine your taxable income (the amount on which you must pay tax) The more deductions you have, the lower your taxable . complex thicket of available deductions, with real-life examples on deducting everything.” ACCOUNTING TODAY 8th Edition Deduct It! Lower Your Small Business Taxes INCLUDES THE LATEST TAX. of Contents Your Tax Deduction Companion 1 1 Tax Deduction Basics 5 How Tax Deductions Work 6 How Businesses Are Taxed 9 e Value of a Tax Deduction 16 What Businesses Can Deduct 20 Businesses. videos. l YOUR TAX DEDUCTION COMPANION|3 How Tax Deductions Work 6 Types of Tax Deductions 6 You Only Pay Taxes on Your Business Profits 7 You Must Have a Legal Basis for Your Deductions