If you’ve operated a home based business for any length of time then you have probably already discovered all of its virtues. You can set your own schedule, choose your own clients and employees, work in your pajamas and you have zero commute. If you are making money, it doesn’t get any better than that. The problem for many home-based business operators is that they don’t always grasp the reality that they are, in fact, business owners. That fact is not lost on the IRS which holds business owners in a special regard, and not necessarily a pleasant one.
As a business owner, you are in business to make a profit which is done by generating more revenue from your products or services than the expenses required to deliver them. Your profit is your income and the IRS is interested in sharing in your profit. As a business owner, and one who would like to keep as much of your profits as possible, it is vitally important to know all of the tax issues that are unique to businesses. In doing so, you will be able to avoid many of the pitfalls and legitimately avoid paying more taxes than is necessary.
Keep Your Lives Separate
This is easier said than done for people who roll out of bed and start their day’s work using a corner of their kitchen as a workspace. But, for the IRS to consider you as a legitimate business owner and to allow you to deduct all legitimate business expenses, you must be able to delineate, both physically and financially, your home life and your business life. You must maintain a separate workspace, with separate business tools, files, equipment, etc., and you need to separate your business finances from your personal finances. In the end, both of these moves will simplify your life, and to a great extent it will help to legitimatize your business in the eyes of your clients as well as the IRS.
Also, the predominant reason to separate your business and personal lives is that it will greatly decrease the time needed to organize, prepare and file your taxes, and it will reduce your anxiety level should an audit be necessary.
Three Key Steps to Separating Your Finances
- Set up separate checking accounts. You will need a federal tax ID to set up a business account. Short of that you can simply establish another personal account that is dedicated to business expenses.
- Use separate charge cards. Most business expenses are paid with a charge or debit card. If you can’t secure a credit card in the name of your business, then use one of your personal cards strictly for business.
- Keep completely separate records. You should have a separate book keeping system for your business that tracks receivables and expenses. Ideally, you should have a workspace that is isolated from your living space so that files, papers, materials and equipment used in your business do not mingle with anything of a personal nature.
Taxation for Business Owners is a Daily Event
As a business owner, you engage in essential activities each and every day that are likely to trigger a taxable event. Whether it’s driving to a meeting, buying coffee for a client, making calls to accounts, buying supplies, taking checks to the bank, buying a book for research, or changing the oil in your car, all of these result in a tax event called a business deduction. This is a good thing, because the more you can deduct, the less amount of your income will be taxed.
The key to maximizing your deductions is to know which expenses are deductible and then to track them vigorously every day. Business owners who wait until the end of the year to find, organize, and sort through piles of receipts and documents are more likely to short change themselves for business deductions. Worse, they are less likely to survive an IRS audit.
By setting up a good book keeping system, you can spend as little as a few minutes each day that will ensure you have accounted for every business activity and expense that will generate a business deduction.
Three Keys to Staying on Top of Your Business Deductions
- Get organized. Get a dedicated file cabinet and create a file system for storing financial documents, statements, receipts, client proposals, communications, invoices and check copies.
- Organize your recordkeeping around allowable business deductions. The place to start is with the Schedule C form filed by all businesses that lists all the categories and expenses for allowable business deductions, such as advertising, insurance, legal fees, office expenses, supplies, travel, entertainment, equipment, dues, etc. You will also want to create a log to track vehicle expenses. Finally, keep a record expenses related to your house, such as utilities, maintenance, insurance, mortgage, etc, as these will be deductible proportionately to the business use of your home.
- Schedule book keeping time. A few minutes a day, or an hour each week will suffice to keep you current and organized. Create a checklist that you can follow in each session to make sure you have recorded receivables, reconciled invoices, logged expenses, and filed receipts.