Can I deduct home office expenses?
Answer: If you use part of your home to conduct your trade or business, you might be able to deduct certain related expenses. To qualify for the home office deduction, you must pass certain tests.
You must use part of your home regularly and exclusively for your trade or business. Exclusive use means that this space is not used for any nonbusiness purpose, such as watching television, during the tax year of the deduction. If the space is used for business only sporadically or occasionally, you may not meet the regular use test.
Also, your home office must be used as either (1) your principal place of business or (2) a place where you meet customers, clients, or patients in the normal course of business. You may also be able to take a deduction if you use part of your home to perform administrative or management duties and you have no other location to do this work. If you are an employee and work from home, the business use of your home must be for the convenience of your employer in order to take the deduction.
Certain expenses for a separate structure, such as a garage, may be deductible if the structure is used regularly and exclusively in connection with your business or trade. A separate structure that’s used in this way does not have to be your principal place of business, or a place where you meet customers, to qualify for the deduction.
If you qualify under these tests, you can deduct certain expenses related to the business use of your home, but your deduction is limited by the percentage used for business and the deduction limit. You can deduct both direct and indirect expenses that apply to the portion of your home that you use for business purposes. Direct expenses are costs expended solely on the part of your home that you use for business purposes, and these can be deducted in full (subject to the deduction limit). They include such expenses as painting, and installation of separate telephone jacks and wiring. Indirect expenses are costs that benefit your entire home, including the portion you use for business. Indirect expenses include mortgage interest, property taxes, insurance, and so on. You may deduct a percentage of these expenses. You may use a square footage calculation or any other reasonable method to compute the business portion of indirect expenses.
If you are self-employed and not a farmer, you must file IRS Form 8829 to take advantage of the home office deduction. IRS Publication 587, titled Business Use of Your Home, offers more information on taking this deduction.
Can I deduct premiums paid for long-term care insurance (LTCI)?
Answer: It depends on several factors. Your LTCI contract must be a qualified one, and the total of your medical expenses (including your LTCI deduction) must exceed 7.5 percent of your adjusted gross income (AGI). Qualified LTCI premiums are deductible as medical expenses (subject to the 7.5 percent of AGI floor) within certain limits, based on your age.
If you bought your policy before January 1, 1997, and it met the requirements of the state in which it was issued, it is automatically considered a qualified policy. LTCI contracts issued subsequently are only considered qualified for a tax deduction if they meet certain federal standards. In 2010, qualified LTCI premiums are deductible as medical expenses (subject to the 7.5 percent of AGI floor) within the following limits, based on your age at the end of the tax year
|Age:||Limit on Deduction:|
|40 or less||$330 (up from $320 in 2009)|
|41-50||$620 (up from $600 in 2009)|
|51-60||$1,230 (up from $1,190 in 2009)|
|61-70||$3,290 (up from $3,180 in 2009)|
|71 and older||$4,110 (up from $3,980 in 2009)|
For more information, consult a tax professional.
I paid my mother’s real estate taxes last year. Can I deduct this on my tax return?
Answer: Probably not. A real estate tax can be deducted only by the owner of the property upon which the tax is imposed. Therefore, if the deed to the property lies in your mother’s name, you are not entitled to a deduction for the real estate taxes even if you are the one who actually paid them. Generally speaking, taxes are deductible in the year you pay them.
Sometimes real estate taxes are prepaid. If you are the property owner, you can generally deduct prepaid real estate taxes in the year of the prepayment if (1) you are a cash basis taxpayer and (2) you don’t live in a jurisdiction where the taxing authority considers prepayment a “deposit.” Jurisdictions vary regarding how they treat prepaid tax. Be aware that taxes placed in escrow generally aren’t deductible.
If I work at home occasionally, am I entitled to a home office deduction?
Answer: To qualify for an income tax deduction for home office expenses, the IRS requires that you meet two tests–the place of business test and the exclusive and regular use test.
To pass the place of business test, you must show that you use a portion of your home as:
- The principal place for any trade or business you conduct, including administrative use. The IRS uses a two-part test to determine if a home office is a taxpayer’s principal place of business. The test takes into account the relative importance of business activities performed at each business location and the amount of time spent conducting those activities at each place of business.
- A place where you meet clients or customers in the normal course of business.
- In the case of a separate structure that is not attached to your dwelling unit, you must show that you use it in connection with your trade or business (i.e., it needn’t be your principal place of business).
The exclusive and regular use test requires that you use that portion of your home both exclusively for business and on a regular basis.
Depending on the nature of your work, your occasional home use is unlikely to qualify for a home office deduction since it is doubtful you would meet the first test (because occasional implies it isn’t your principal place of business). You are also unlikely to satisfy the second test (because occasional implies that the use of your home isn’t exclusive or regular).
Because the rules are complicated, it might be wise to review IRS Publication 587, titled Business Use of Your Home, or consult a tax professional.
We just bought our first home. What can we deduct from the settlement statement?
Answer: If you took out a mortgage to purchase your home, you probably paid settlement costs in addition to the contract price. These costs generally include points, attorney’s fees, recording fees, title search fees, appraisal fees, and other loan or document preparation and processing fees. The only settlement costs you can deduct are home mortgage interest and certain real estate taxes. You deduct them in the year you bought the home if you itemize your deductions. Certain settlement costs can be added to the basis of your home. Other settlement or closing costs, however, cannot be deducted or added to the basis.
If the loan was for the purchase of your primary residence, the points withheld from the loan proceeds will generally be deductible as up-front interest if you paid a down payment, escrow deposit, or earnest money equal to the charge for points. Generally, you can also deduct any points paid by the seller. Real estate taxes are usually divided so that you and the seller each pay taxes for the part of the property tax year that each owned the home. You can deduct the taxes you actually paid during the year. However, you cannot take a present deduction for taxes paid in escrow for a future tax bill.
Other closing costs that you paid are not deductible and must be added to the cost basis of your home. You can include in your basis the settlement fees and closing costs that you paid that are associated with buying your home. You cannot include in your basis the fees and costs associated with getting a mortgage loan.
Are my Social Security benefits subject to income tax?
Answer: A portion of your benefits may be subject to income tax if your modified adjusted gross income (MAGI), plus one-half your Social Security benefits, exceeds specific limits. Your MAGI equals:
- Adjusted gross income (or the adjusted gross income of you and your spouse if married and filing jointly), including wages, interest, dividends, taxable pensions, and other sources,
- Tax-exempt interest income (e.g., interest from municipal bonds and qualified U.S. savings bonds), and
- Amounts earned in a foreign country, U.S. possession, or Puerto Rico that are exempt from tax
Up to 50 percent of your Social Security benefits may be subject to income tax if your combined income (MAGI plus one-half your Social Security benefits) exceeds $25,000 for an individual filing single, unmarried head of household, or qualified widow(er) with dependent ($32,000 if married and filing jointly).
If your combined income exceeds $34,000 ($44,000 if married and filing jointly), up to 85 percent of your benefits is taxable. If you are married and filing separately, up to 85 percent of your benefits will be taxed unless you and your spouse live apart for the entire year.
Consult an accountant or other tax professional for more information. Or, contact the Internal Revenue Service at (800) 829-1040 or www.irs.gov. Ask for Publication 554, Tax Guide for Seniors, and Publication 915, Social Security and Equivalent Railroad Retirement Benefits.
Do I have to pay U.S. taxes when I work abroad?
Answer: If you are a U.S. citizen working abroad, you may be able to minimize what you owe in U.S. income tax if you qualify for the foreign income exclusion. If you qualify, you may exclude up to $91,500 in foreign income from U.S. income tax liability in 2010. If you are married, your spouse is allowed an additional $91,500 exclusion. To qualify, you and your spouse must satisfy the following requirements:
- You must reside in a foreign country for an entire tax year or for at least 330 days during a 12-month period
- Your salary must be paid by a company or agency in your country of residence or by a U.S. company operating in that country
Also, only earned income–salaries, wages, and fringe benefits, plus allowances and expenses for housing–qualifies for the exclusion. Dividends, interest, capital gains, pension or retirement distributions, and alimony do not qualify. If you are a member of the U.S. military or other government service and are living abroad, your income is not considered foreign income. You’ll have to pay taxes as if you were a taxpayer living in the United States.
Even if you avoid U.S. income tax, you will likely pay some form of income tax to the country in which you reside and earn a salary. Should you fail to meet its residency requirements, or if you receive income above the allowable exclusion, you’ll probably end up paying both foreign and U.S. income tax. If you do pay foreign income tax, you can apply for a separate U.S. tax credit (using Form 1116) in the amount of foreign income tax you are required to pay.
You’ll also owe U.S. Social Security taxes if your country of residence has no treaty to coordinate its social service coverage with the United States. However, if such a treaty is in force, you’ll pay foreign social service taxes to your host nation and will not be required to pay U.S. Social Security taxes. In addition, you may be subject to estate and gift taxes if you transfer property, no matter where that property is located. If you maintain a house in the United States, you may owe state income tax and local property tax. For more information, consult a tax advisor or contact the IRS at (800) 829-3676 or www.irs.gov and request Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.
Don’t most small businesses fail?
Answer: Although it’s true that many new small businesses go under within their first year or two, there are usually reasons that can explain their failure. If you’re aware of the pitfalls associated with the start-up of a new enterprise, you can take steps now to maximize the chances that your business will succeed.
Don’t start a business you know nothing about. If you’re a pastry chef, don’t open an auto-body shop. Your experience, skill, and knowledge of the business you wish to run are key to its success.
You’ll want to conduct extensive market research to determine if the product or service you will offer is currently in demand. Define who you’re marketing to and target your message to them. Also, consider the most favorable time to market your product or service (e.g., toys at Christmas). Of course, another key to your success is location, location, location. Finally, plan your advertising campaign and consider how you will distribute your product or service.
Pay attention to your competition. Be sure your product or service offers your customers something your competitors do not.
Set up a written business plan detailing the design of your business growth. Organize a start-up team of people who have abilities you lack. Determine how you will obtain the capital to finance your project, and be sure you have adequate capital. More importantly, make sure you have enough to live on. Many new businesses do not generate income immediately. Finally, include in your business plan an exit strategy for closing the business should things not work out as you had hoped.
How do I find good advisors such as lawyers and accountants to help with my business?
Answer: To run your business successfully, you may need advice in a number of diverse areas such as fin`ancial planning, accounting, law, taxation, insurance, and investment management. For this you may have to hire one or more advisors. Before you hire an advisor, however, it is important to understand your needs, because a well-chosen advisor can point your business in the right direction and help you achieve your goals.
When looking for a particular advisor, start with a referral from someone you have worked with previously, or with word of mouth from colleagues you respect. If that doesn’t work, call a local referral agency or local professional association. Other options include the yellow pages and advertisements in the local media.
Before your initial meeting with the advisor, prepare a list of questions and topics you wish to discuss. Topics you may choose to cover include the advisor’s experience, education, credentials, licenses, area of specialization, and references. After your initial meeting with the advisor, evaluate the meeting. Ask yourself the following questions:
- Did the advisor listen to you?
- Did the advisor understand your situation completely?
- Does the advisor work with other people in your business?
- Did the advisor make any suggestions or offer any advice?
- Is the advisor willing to work with other advisors?
- Did you feel comfortable with the advisor?
If you’re satisfied with the answers, you may have identified someone to help you with your business.
Is buying a franchise a good way to get into business?
Answer: Though far from simple, franchising can be a good way for you to own a business with both a proven method of operation and a familiar name and trademark. Before choosing a franchise, consider your interests, experience, knowledge, and personality. Though your franchisor will likely offer managerial support and training, you will be more successful if you have an interest in or experience with the business in which your chosen franchise operates. For example, a former restaurant manager might be more successful in acquiring a fast-food restaurant than a muffler shop.
Don’t forget the fees and restrictions that come with franchise ownership. Do you mind paying royalties or relinquishing some control to the franchisor? For example, the franchisor typically can dictate things such as the style of uniforms, the way the product is presented, and even where you buy your supplies. If such franchisor control will bother you, franchising may not be for you.
When you have chosen one or more franchises in which you are particularly interested, you’ll need to examine each very closely. Your examination should include a careful review of the franchisor’s Uniform Franchise Offering Circular (UFOC), a document containing information submitted to the FTC that the franchisor is required by law to provide you with before you sign a contract. In addition, you should investigate the franchisor’s credibility by contacting other franchisees and consumer agencies like the Better Business Bureau. It may be wise to contact some franchisees who have failed, so you can get a balanced view of the risks.
Last but not least, you should seek the advice of professionals who are familiar with franchising, such as a lawyer and an accountant. They can help you understand the franchise agreement, which is usually long and complicated, before you commit to it.
Should I buy an existing business or start from scratch?
Answer: That will depend on the specific type of business you want to own and the area in which you choose to operate. An existing business may offer a familiar product or service with an established base of customers, suppliers, and employees. For some people, the simplicity of starting out in an established business outweighs the disadvantages, including a higher purchase price.
However, an existing business may not be for sale in the industry, field, or region you have chosen. Some businesses that are for sale may not be good buys. For example, the equipment may be outdated, or the business may not be highly regarded in the community. The business may already have a reputation and course of dealings that could be very difficult to change, and you may be buying the seller’s headache. In other words, the reason the business is for sale may be a good reason for you not to buy it.
If you have a brand-new idea, there may be no other businesses engaging in the product or service you plan to provide. The absence of an existing business may force you to start your own from scratch. Even if a business is for sale in your chosen field or region, you may still choose to start your own for any number of reasons, including the purchase cost and your access to suitable financing.
Before deciding to buy an existing business or to start one on your own, engage in some research. Study the industry, the competition, and your target market. Consider the type of business you want, where you would like to operate, and your access to financing. Your research may indicate whether it is less costly to start your own business or to buy a going concern. As you evaluate your options, remain open to all of the possibilities.
Should I buy or lease assets for my business?
Answer: This decision depends on several factors, such as the cost of the asset, your cash and/or credit position, and the asset’s value to you now and in the future.
In the short term, leasing an asset allows you to try out a product without making a lengthy commitment. If you find the item does not meet your needs, you are not stuck with it as you might be if you had bought it and had difficulty reselling it. For items that quickly become technologically obsolete (e.g., computers and communications equipment), successive leasing allows you the flexibility of upgrading. In most cases, a lessor (particularly of office equipment) will also provide maintenance support on the items you lease.
Buying an asset provides you with equity. But it may also require a substantial cash outlay for an outright purchase or a down payment. Certainly, obtaining credit for a large purchase (e.g., an office building) may be difficult, and credit for leases is easier to obtain.
In contrast, you will likely spend more dollars by leasing over the life of the asset than you would with a purchase, even if you consider the interest payments on a loan. This is particularly true with real estate. The interest you pay on loans to acquire real property may be tax deductible as a business expense, as may maintenance costs and depreciation on the asset. Also, even though most lease payments are fully deductible as business expenses for tax purposes, your purchase of the asset may provide greater tax relief in the long term.
As a general rule of thumb, buy the asset if it will increase in value over time and you plan to keep it more than five years. If the asset will decrease in value, lease it.
What are the stages of business development?
Answer: Generally, businesses experience four stages: start-up, growth, maturity, and decline.
Start-ups are businesses that have recently come into existence. Before revenues are generated, businesses in the start-up stage generally require a large investment of time, effort, energy, and money to create a stable customer base, buy inventory, and engage in other business activities. The start-up stage is generally characterized by innovation, high risk, and low profit margins.
Businesses in the growth phase can often function using their own limited resources. Ideally, during this stage, consumer demand is established and increases. Additional help is often needed in production, manufacturing, general operations, or sales in order to continue growing. The company typically experiences increasing sales and profit margins as a market is established.
Mature firms have achieved a certain amount of name recognition. Contacts are well established, sales require less effort, the business produces a reliable stream of cash, and borrowing becomes easier. At this point, intensive marketing may be needed to increase or maintain market position, and little product innovation occurs. Profit margins tend to stabilize.
Businesses in the declining phase tend to experience a shrinking market. There is usually no product innovation, costs are cut to preserve profits, and the profits that remain are usually thin.
The time it takes to reach or to pass through each stage varies by business. It is important that you properly identify the life-cycle stage of your business so that you can plan appropriately and establish realistic goals for the future.
What should I look for in a business location?
Answer: The type of business you choose to operate will affect the specific factors you must consider when looking for a location. Some businesses need high visibility and high foot traffic, while others may not even need a sign. If you are operating a retail outlet, visibility, pedestrian traffic, and available parking may be crucial to your success. However, if your business is highly specialized (e.g., violin restoration), customers may go out of their way to find you after they learn of the service that you can offer to them.
Some of the considerations when choosing a location include:
- Do you need a separate facility? Should you own it or lease it?
- Are there any environmental restrictions that may apply to your business if it locates in a particular area?
- What are the zoning laws?
- Does your business lend itself to an industrial park, a downtown district, or a rural location?
- Will the local government (i.e., city hall, county clerk) require a permit or taxes to operate in a certain location?
- Are there additional costs associated with certain locations, such as higher rental rates, or higher income or property taxes?
- What are your likes and dislikes about locations that you patronize? Try to look at potential locations as a customer might.
If you are planning to run your business from your home, remember to check local zoning requirements. Some communities do not allow businesses of any type (not even private piano lessons) to operate in residential areas.
Can I borrow money from my wholly owned business?
Yes, you can borrow money from your wholly owned business. Generally speaking, the terms of the loan must be reasonable and must be properly documented. Otherwise, you run the risk that the IRS could reclassify the proceeds of the loan as compensation or dividends, leaving you with an unanticipated tax bill. Troubles may arise if you fail to structure a loan that is reasonable, based on current market conditions. The IRS can impute interest on the loan if the interest rate is too low, which would result in the business paying taxes on interest that was not received.
The loan should be documented with a promissory note signed by you and an authorized representative of the business. The note should include details regarding the amount loaned, the repayment schedule, and the interest rate. You should make the payments as required under the agreement to avoid the reclassification of the loan. Consult your tax professional to make sure that your loan will pass muster in case of an audit.
How can I raise capital for my business?
The two general categories of financing available for businesses are debt and equity. Debt requires repayment of a loan. Equity involves raising capital by selling parts of the business to investors.
How much money your business needs, what the financing is needed for (start-up, expansion, new development), as well as how your business is organized, its size, and its stage in the business life cycle (start-up, growth phase, mature) are just a few of the things that may influence your efforts to raise capital.
If yours is a new business without a track record, you may have difficulty raising capital from lenders or investors. A first place to look for capital might be your own assets. You may be able to raise money for the business from your savings or borrow against a retirement plan, life insurance policy, credit card, or the equity in your home.
If your business is more established, you may be able to borrow from a number of sources. You can apply to banks or credit unions for loans. You can contact the Small Business Administration for information on the programs it administers to help businesses obtain financing. Your local chamber of commerce may be able to put you in touch with state and local agencies that provide financial assistance to new businesses located within your geographic area. You need to have a detailed business plan to provide to potential lenders or investors.
Your options to raise equity may include wealthy private investors known as angels, venture capital firms, private placement of equity, and investment clubs. Small business investment companies may act as lenders or investors. For some corporations, an initial public offering is used to generate large sums of cash through the sale of company stock. A potential drawback of equity financing is that investors may expect to exercise some control in the running of the business.
There are also internal business sources for raising business capital. Consider offering incentives to your customers for early cash payment (such as a discount) to accelerate your collections and free up operating cash. You may choose to lease company assets rather than buy them. Finally, your company may be able to negotiate special delayed-payment terms with suppliers or factor accounts receivable, which entails getting an advance on money owed to you.
Should I incorporate my business?
Answer: Operating as a sole proprietor is often the simplest and least expensive way to organize your business. Even so, many business owners choose to incorporate their businesses. But taking that step has both advantages and drawbacks.
A chief advantage of incorporation is that the business assets of the corporation can be separated from your personal finances. As a result, your personal assets generally can be shielded from creditors of the business if you incorporate your business.
To maintain this legal separation (known as the corporate veil), you must observe certain formalities. For instance, you must keep corporate assets separate from personal assets, hold periodic shareholder meetings, and file reports required by various government agencies, including a separate tax return. The costs of establishing and maintaining corporate formalities are a disadvantage of incorporation and must be factored into your decision.
Another possible disadvantage of incorporation is double taxation of income. Double taxation means that after the corporation pays tax on its earnings, you must pay tax on corporate earnings distributed to you as dividends by the corporation. In many instances, corporations with 100 or fewer shareholders can avoid double taxation by electing to be treated as S corporations.
Before deciding to incorporate, you should seek legal and tax advice on what type of ownership best suits your business. Other forms of ownership may offer your company the advantages of incorporation (such as limited liability), but also offer more management flexibility or tax advantages. You might also want to consider how big you expect the business to grow, and the sources of financing you expect to tap. An experienced attorney and tax advisor can help you decide which form of ownership is best for your business.