by Kimberly Grob, special to CalCPA Online
Editor's note: This is the fourth of a four-part series on starting a small business. The other articles discuss creating a business plan, legal structure and obtaining financing.
Phone bills. Computers. Faxes. Payroll. When starting and growing a new business, expenses begin to pile up, but savvy entrepreneurs can offset some of these expenses by preparing for and claiming tax deductions. If you keep good records and file your tax return properly, you can deduct some of the costs associated with your home office, your health insurance, and even the gifts you give to clients.
Naturally, your primary concern needs to be selling your product or service. Don't fall into the trap described by Howard Thomas, a CPA and president of the Thomas Consulting Group, a firm that specializes in small business consulting in Los Gatos. "Many entrepreneurs get preoccupied too early with saving on taxes. Instead, they need to focus on finding a customer and selling," he warns.
But while there's more to starting a business than saving on taxes, says CPA Craig Malmgren, a tax manager at Lautze and Lautze in Oakland, you obviously need to identify which expenses to track. "Talk with a CPA," he says. "When you're setting up a new business, a CPA can give you an introduction to the deductions your business may be able to use. And seeing a CPA early doesn't only help you save on taxes, it can also help you make more money."
Deduction Dos and Don'ts
The following taxation and recordkeeping advice will help you and your CPA track your deductions successfully.
Don't rely on estimates. "Keep track of anything that might be a business-related expense," says Malmgren. "At tax time, you won't be able to rely on your memory. And the IRS is not in a position to take estimates."
Don't pay for expenses with cash. In order to deduct expenses at tax time, you need a record. A check number or a credit card bill can serve as documentation.
Set up a reliable bookkeeping structure. "You need to know how well you're doing," says Malmgren. If you've made sales, but haven't collected the money, your monthly records will give you an accurate account of your business' earnings.
Maintain a separate bank account for your business. The IRS is becoming more meticulous about examining home-based business filings, since some hobbyists will attempt to file a Schedule C to deduct expenses related to their hobby. Keeping careful records and maintaining a separate bank account for business expenses will help you prove that your business is a legitimate, money-making venture.
Don't ever make a business decision exclusively because of the tax benefits. "Your business isn't about saving taxes," says Thomas. "Instead, you need to focus on how you're going to make money."
Key Deductions to Consider
"Deductions can get complicated," says Malmgren. Consulting with a professional preparer is the best way to determine how to use deductions for your particular business and situation. However, some key deductions are widely applicable.
Home office. If you're setting up a home office for your new business, it must meet specific requirements to qualify for a deduction in 1999. First, the home office must be your principal place of business. It must be used exclusively and regularly for administration or management activities. And, you must not have any other fixed location where you regularly conduct these activities.
Depreciable property. When you buy equipment or machinery for your new business, you may be able to write off the entire cost of the property in the first year rather than depreciating it over a period of years. This is called an "election to expense" deduction, and you can elect up to $18,500 of qualified depreciable property.
Health insurance. Being self-employed means paying for your health insurance. The good news is that in 1999, tax deductions for small-business health insurance premiums have increased to 60 percent. The deduction will reach 70 percent in 2002 and 100 percent in 2003.
Cellular phone. If you purchase a cell phone for your new business, you may be able to deduct the calls. The catch? The IRS will expect you to prove that the calls are business-related. If you keep track of your monthly cell phone bills, and if those bills itemize your calls, then you may be able to take advantage of this deduction.
Mileage and travel. Travelling between your home office and other work locations is a deductible expense, so as you begin using your vehicle for business, you'll need to keep careful records of your gas and mileage expenses. In 1999, the standard mileage rate deduction is decreasing from 32.5 cents per mile to 31 cents per mile.
Education. If you attend business startup seminars or other professional courses, you can deduct the expenses, as long as you can demonstrate that the courses are ordinary and necessary to the operation of your business.
Bad debt. Once your business gets rolling, you'll probably have at least one run-in with bad debt. And if you're unable to collect from a customer or client, the IRS will allow you to deduct the amount of the bad debt. However, you must be able to produce detailed records that show you've taken reasonable measures to collect the debt.
CPAs Can Help
These deductions only scratch at the surface of what might be applicable to your business. And each year, the tax code is subject to change. New deductions may become available while old deductions may change or phase out. This is where your CPA can help. To optimize your deductions and ensure that you haven't overlooked anything, you'll need to consult with a professional about the appropriate tax-related actions you need to take.
And this is one area where you shouldn't try to cut costs. "When you're first starting your business, seeing a CPA may seem too expensive," says Malmgren. "But you'll save in the long run."