Business Basics: Collecting and Protecting Tax Deductions
So, you’ve decided to start your own business. It’s a great way to earn a living, get some control over your money, and more importantly, get some control over your time.
I want to talk to you about a few business basics today that will let you work and lower the cost of getting your accounting and your taxes done. We’ll talk about organizing your business finances, simplifying business accounting, and protecting your tax deductions.
So the first thing you need to do if you’re going to go into business is get your Business and Federal ID number. You can do this by filing form SS4, the application for employer Identification number. It’s easy to obtain, you can phone the IRS, you can stop in at a local office or you can download it at IRS.gov. Again, that’s form SS4. I think you’ll find this one page form easy to complete, and self explanatory. The only thing that trips up some people is whether or not you are going to have payroll. They have a couple of questions on payroll if you’re not going to have any payroll, just put N/A and none where the questions are asked so that it prevent you from getting any payroll forms and any letters of correspondence from the IRS related to payroll that you don’t want. Once you’ve got your new 9-digit IRS number, you’re ready to take it out and provide it to those people you are doing business with as an ID number that will separate your business from your social security number.
Step two is to go and create two buckets to hold all of your business transactions. The first bucket is to set up a company checking account. It’s not important that the checking account be in the name of the business but it’s a good idea. The big idea is to separate the business transactions from the personal transactions. The second bucket that you are going to get is a credit card that you can dedicate to business expenses only. Again, the ideas is that we have these two buckets, it makes it easy to summarize everything when the time comes. And two, it gives the business it’s own integrity. The integrity becomes really important if you ever get audited because in most audits the IRS is going to ask for all of your bank accounts. If they’re auditing your business, they are going to look at the business bank accounts if you separated them from yourself personally, but if you’ve co-mingled all of your business transactions with your personal transactions the IRS is going to have to go through every personal bank account that you have in order to complete the audit. If you run out of money in your checking account you can always loan it to the business and let the business repay it when the time comes. The important thing is to separate the business and the personal. Similarly on the credit card, if you have a business credit card that runs a balance you’ll be entitled to deduct the interest expense that runs on that credit card, but if you co-mingle business and personal credit card charges the IRS won’t allow you to take any interest expense deduction.
The last thing is protecting your auto expenses and your meals and entertainment expenses. Most businesses run some amount of both of those types of expenses. Many of our business expenses are subject to what the IRS calls the reasonableness standard and that is even without perfect records, if it’s typical for someone in your line of work to incur that type of expense, you’ll be entitled to a deduction even if you don’t have perfect proof of it. Unfortunately, that’s not true for your auto expenses or your meals and entertainment expenses. Both of these require specific written records of support. No written records, no deduction. In fact, it’s so bad that if you take the deduction and don’t have the support, you’ll suffer penalties and your tax preparer will also suffer penalties for having claimed deductions that didn’t have the written records.
So let’s talk first about your auto expenses. Your auto expenses can be tracked in two different ways for tax purposes. The first method is called the optional method. The second way is called the actual method. With the optional method, you track all of your business mileage through the year and at the end of the year you multiply it times a rate that the IRS gives us. The IRS changes that rate every year but for 2009 they are going to give everybody 55 cents a mile for any business miles they have. Sometimes a bigger deduction comes if you can use the actual method. To use the actual method you have to use your car more than 50% for business, so it has to be over half of the use of the car once your business is underway. Like the optional method, you have to track all of your business mileage and then you compare your business mileage to your total mileage to come up with what percentage was business use of your car. You add up all the cost of operating your car for the year which would include any interest that you’re paying on a loan, if you’ve got a car loan, and would include all the lease payments that you make on a car if you’re leasing your car. So you get the deduction for your car license, for all of you operating costs like gas, insurance, and repairs, and you get some amount of deduction for the interest expense, maybe some depreciation on your car if you’re buying it, or the lease payments if you’re leasing your car. The hard part under both of them is tracking your business mileage.
The IRS has tried to be reasonable about doing that and have several different methods they will let people do but that’s beyond the scope of this video and so I’ll ask you to look at it alter or give me a call if you’d like more information on that. The point here is the easy accumulation of the data by paying all of your auto expenses with your business checking account or with your business credit card so that we can easily accumulate them all and tally them up when it comes to year end and decide what’s the best deduction for you.
Lastly, let’s talk about your meals and entertainment expense. Like auto expenses, you have to have specific written records. For your meals and entertainment expense, the IRS requires that you have five pieces of information for each time you have a meal or entertainment expense. They want to know who, when, where, how much is spent, and what your business purpose was. This is where the credit card pays off because the credit card receipt that you have to sign at the end of your meal is going to automatically collect three pieces of information: where you’re at, when you were there, and how much you spent. When you’re signing your receipt, you just write down the names of the people who are there with you and a short note about what the business purpose of the meeting is then you’ve just bullet proofed your meals and entertainment expense. A great, easy way to collect the data required by the IRS.
To summarize, first get your business a federal id number, separate the business from you the person, and minimize your tax and audit responsibilities. Second, make your accounting easy by getting a business checking account and dedicating one credit card to the business. Third, if you have significant auto expenses record all of your mileage and pay all your expenses connected to the car through your business. Lastly, use the credit card to pay for all of your meals and entertainment expenses. Write down who and what the business purpose is on your credit card receipt and then save it and bullet proof your tax deduction.
That’s the basics. If you’d like more details or other ways to save money, give me a call. Thanks for listening. I wish you much success in business and in life.