Small business tax deductions can save a great deal of money on taxes. I have always said that your own small business can be your best tax deduction. The other day I mentioned this at my Arizona Boot Camp. One of the attendees mentioned that starting a business just to save taxes was illegal. The truth is you can start a business to save taxes.
It is important that you understand the difference between a business and a hobby. A hobby is something that you engage in “not for profit.” You start a business to make a little money. This is an important distinction for the IRS because incorrect deductions of expenses and overstated adjustments, deductions, exemptions and credits account for more than $30 billion per year in unpaid taxes, according to IRS estimates.
You can bet that the IRS is serious about the distinction between a business and a hobby and you should be too. The following is a list of the conditions the IRS uses to determine if an activity qualifies as a “true” business. Of course you don’t need to meet every one of these, but you need to meet enough to be convincing.
- Do you put enough time and effort put into your business to show an intention to make a profit or at least depend on income from the business?
- Do your losses come from circumstances beyond your control or in the start-up phase of your business?
- What operational changes are you making to improve profitability?
- Do you or do your advisors have the knowledge needed to carry a successful business?
- Have you made a profit in a similar business in the past?
- Does your business make a profit in some years?
- Will you make a profit in the future from the appreciation of business assets?
You can even lose money in the business, but you must intend to make a profit.
Once you have a “true” business, you can deduct all the “ordinary and necessary expenses” you have for conducting that business. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is appropriate for the business.
Be careful and accurate on how much you deduct. Only apply those deductions that might be reasonable and customary for your industry. The IRS will assume that you have a business if you have real profit intent. This is true for individuals, partnerships, estates, trusts, and S corporations.
The take home message is that you can form a business to take tax deductions, but it must be a true business. If you have business in place, you want to be certain you are taking advantage of all the deductions possible. Take a look at my 10 Tax Tips for more ideas. It will show you how to take advantage of the great deductions in the IRS code for small businesses.