Even if you choose to hire a tax expert to do your business taxes.. be informed!! Having a basic understanding of how to calculate your taxes and what tax benefits are available will help you keep more of your profits and may even qualify you for a refund.
What you don’t know CAN cost you!!
Visit http://www.irs.gov/businesses/small/article/0,,id=109807,00.html It will look like this:
What Can I Deduct?
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.
It is important to separate business expenses from the following expenses:
• The expenses used to figure the Cost of Goods Sold,
• Capital Expenses, and
• Personal Expenses
Cost of Goods Sold
If your business manufactures products or purchases them for resale, you generally must value inventory at the beginning and end of each tax year to determine your cost of goods sold. Some of your expenses may be included in figuring the cost of goods sold. Cost of goods sold is deducted from your gross receipts to figure your gross profit for the year. If you include an expense in the cost of goods sold, you cannot deduct it again as a business expense.
The following are types of expenses that go into figuring the cost of goods sold.
• The cost of products or raw materials, including freight
• Storage
• Direct labor costs (including contributions to pensions or annuity plans) for workers who produce the products
• Factory overhead
Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs.
This rule does not apply to personal property you acquire for resale if your average annual gross receipts (or those of your predecessor) for the preceding 3 tax years are not more than $10 million.
For additional information, refer to the chapter on Cost of Goods Sold, Publication 334, Tax Guide for Small Businesses and the chapter on Inventories, Publication 538, Accounting Periods and Methods.
Capital Expenses
You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called capital expenses. Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize.
• Business start-up cost (See the note below)
• Business assets
• Improvements
Note: You can elect to deduct or amortize certain business start-up costs. Refer to chapters 7 and 8 of Publication 535, Business Expenses.
Personal versus Business Expenses
Generally, you cannot deduct Personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part.
For example, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you can deduct 70% of the interest as a business expense. The remaining 30% is personal interest and is not deductible. Refer to chapter 4 of Publication 535, Business Expenses, for information on deducting interest and the allocation rules.
Business Use of Your Home
If you use part of your home for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Refer to Home Office Deduction and Publication 587, Business Use of Your Home, for more information.
Business Use of Your Car
If you use your car in your business, you can deduct car expenses. If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. Refer to Publication 463, Travel, Entertainment, Gift, and Car Expenses. For a list of current and prior year mileage rates see the Standard Mileage Rates.
Other Types of Business Expenses
• Employees' Pay - You can generally deduct the pay you give your employees for the services they perform for your business.
• Retirement Plans - Retirement plans are savings plans that offer you tax advantages to set aside money for your own, and your employees' retirement.
• Rent Expense - Rent is any amount you pay for the use of property you do not own. In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. If you have or will receive equity in or title to the property, the rent is not deductible.
• Interest - Business interest expense is an amount charged for the use of money you borrowed for business activities.
• Taxes - You can deduct various federal, state, local, and foreign taxes directly attributable to your trade or business as business expenses.
• Insurance - Generally, you can deduct the ordinary and necessary cost of insurance as a business expense, if it is for your trade, business, or profession.
Here is a little more clarification of concepts you will see in the IRS:
Cost of Goods Sold:
Calculating manufactured Cost of Goods Sold (COGS) for one taxable year:
Beginning Jan 1st Inventory value (cost of goods)
Plus purchases of materials used to produce new inventory
Plus “freight in” (shipping of materials in to you)
Plus Storage of inventory
Plus employee wages used to make the product from purchased materials
Plus factory overhead
Less ending value of inventory on hand December 31st. T his is also beginning figure for next year!
Calculating retail Cost of Goods Sold (COGS) for one taxable year:
Beginning Jan 1st inventory value (your of these goods)
Plus purchases
Plus “freight in”
Plus storage
Less ending value of inventory on hand December 31st. This is also beginning figure for next year!
Expenses to include in “Factory Overhead” :
Factory rent, property taxes, depreciation
Misc items or supplies used in general production
Utilities
Repairs
Maintenance
Security
Insurance for factory and equipment
Other factory personnel indirectly related to production
Capital Expenses:
Capital Expenses or Expenditures are payments by a business for fixed assets, like buildings and equipment. Capital expenses are not used for ordinary day-to-day operating expenses of a business, like rent, utilities, and insurance. (http://biztaxlaw.about.com/od/glossaryc/a/capitalexpense.htm)
However, the cost of your capital assets can be depreciated or amortized (expensed) over time.
“Depreciation is an income tax deduction that allows a taxpayer to recover the cost of certain property. It is an annual allowance for the wear and tear, deterioration, or obsolescence of the property.
Most types of tangible property (except, land), such as buildings, machinery, vehicles, furniture, and equipment are depreciable. Likewise, certain intangible property, such as patents, copyrights, and computer software is depreciable.” (www.irs.gov/businesses/small/article/0,,id=137026,00.html)
Amortization is depreciation of your intangible assets (patents, copyrights, leaseholds…)
Personal Expenses:
When you use your home or car for your business go ahead take advantage of that tax deduction.. just make sure you fully understand the limitations outlined in the provided IRS publications and document your business use. If you get audited your records will support your case.
Other Deductable Business Expenses:
The IRS site is pretty clear about these, they do not change too much from year to year, and the site does provide some great publications on these topics.
Warning: be careful not to deduct business expenses twice!! If you used an employee’s wages or property tax expenses to calculate COGS you can not take the deduction again as “Other Deductable Business Expenses!” This is an easy mistake to make but could be a costly one if the IRS catches it before you do.
How About Tax Credits?
You may also have heard that you can take a tax credit.. that is.. take money off your taxes owed (this is in ADDITION to deducting the wages to calculate your business tax .. tax credits comes off the final number on your business tax return… for instance: hiring youth in the summer, family members on assistance programs or veterans can give you additional tax breaks for your business through the Work Opportunity Credit.
I repeat… business tax credits are in addition to the business expense deductions.
Visit this IRS site for a complete list of tax credits and don’t miss out!
(www.irs.gov/businesses/small/article/0,,id=99839,00.html)
“All of the following credits, with the exception of the electric vehicle credit, are part of the general business credit. The form you use to figure each credit is shown below.”
• Form 3800, General Business Credit (PDF)
• Form 3468, Investment Credit (PDF)
This consists of the sum of the rehabilitation, energy, and reforestation credits.
• Form 5735, American Samoa Economic Development Credit (PDF)
• Form 5884, Work Opportunity Credit (PDF)
• Form 6478, Credit for Alcohol Used as Fuel (PDF)
• Form 6765, Credit for Increasing Research Activities (PDF)
• Form 8586, Low-Income Housing Credit (PDF)
• Form 8611, Recapture of Low-Income Housing Credit (PDF)
• Form 8820, Orphan Drug Credit (PDF)
• Form 8826, Disabled Access Credit (PDF)
• Form 8834, Qualified Electric Vehicle Credit (PDF)
• Form 8835, Renewable Electricity Production Credit (PDF)
• Form 8844, Empowerment Zone Employment Credit (PDF)
• Form 8845, Indian Employment Credit (PDF)
• Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips (PDF)
• Form 8847, Credit for Contributions to Selected Community Development Corporations (PDF)
• Form 8864, Biodiesel and Renewable Diesel Fuels Credit (PDF)
• Form 8874, New Markets Credit (PDF)
• Form 8881, Credit for Small Employer Pension Plan Startup Costs (PDF)
• Form 8882, Credit for Employer-Provided Childcare Facilities and Services (PDF)
• Form 8896, Low Sulfur Diesel Fuel Production Credit (PDF)
• Form 8900, Qualified Railroad Track Maintenance Credit (PDF)
• Form 8906, Distilled Spirits Credit (PDF)
• Form 8907, Nonconventional Source Fuel Credit (PDF)
• Form 8908, Energy Efficient Home Credit (PDF)
• Form 8910, Alternative Motor Vehicle Credit (PDF)
• Form 8911, Alternative Fuel Vehicle Refueling Property Credit (PDF)
• Form 8923, Mine Rescue Team Training Credit (PDF)
Other Helpful Resources:
Besides the IRS site to answer your tax questions (and don’t forget you can call the IRS with tax questions too) I found these websites to be very informative and easy to navigate:
CompleteTax
www.completetax.com
BizTaxLaw
www.biztaxlaw.com
You are invited to share your business tax experience with a post. Wishing you the best this tax season!
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