As a small business owner you may be opening yourself up to increased tax audits as a result of misusing deductions for your small business. If you are a first-time business owner you more than likely have a few questions concerning the use of these tax deductions. Even if you have been in business for a while you could be using these tax deductions incorrectly. Here are two often-misused tax deductions:
1. Home Office Deduction- Many business owners have shied away from using the home office deduction for fear of it creating an audit “red-flag”. However, if used correctly the small business owner can use this deduction for their situations.
One important note on the Home Office Deduction is that there are 2 ways to calculate the deduction. Also remember, that in order to use the Home Office Deduction you must be show that you use your home as your principal place of business.
- The first way to calculate the Home Office Deduction is using the Actual Expense Method. This method requires you to take the square footage of your office and divide it by the total square footage of your home. The percentage you end up with is the percentage of home expenses that you can deduct for your home office.
When using the “Actual Expense Method” you will be able to deduct the calculated percentage on your home expenses (utilities, homeowners or rental insurance, mortgage interest or rent payments, etc.). This can me a longer process to calculate but the potential for increased tax deductions is worth keeping good documents to help with the calculations.
- The second method to calculate the Home Office Deduction is the “Safe Harbor Method”. This method gives a standard deduction of $5/ square foot of the home used for business, up to 300 square feet. This method is easier to calculate but could restrict the small business owner from using certain deductions.
When determining which method to use consider the size of the deduction you expect to have. It could be worth the extra work. Also, it is always advisable to work with your CPA or tax advisor to ensure you are using the deduction and documenting expenses correctly.
2. Auto Expenses- Often business owners look for ways to deduct driving/ auto expenses. Keep in mind that expenses related to the use of business owner’s cars for work related purposes could be deducted. However, taking a deduction for commuting to and from the office is not a deductible expense. Like the home office deduction there are two ways to calculate this deduction.
- First, is the Actual Expense Method: This method will allow the small business owner to deduct all business related driving expenses incurred over the course of the year. This means good documentation should be kept when using the actual expense method. If the use of your car is both work and personal you should keep a log of travel related to business. This should include date, millage to and from business related expense, gas, car maintenance/ repair costs.
- The second method is the Standard Millage Rate. - The Standard Millage Rate only looks at the millage you drive for business related activities. You would simply take the number of miles you drive each year and multiply it by the standard millage rate. For 2016, that was 54 cents per mile. The standard millage rate takes into consideration gas, insurance, auto repairs, depreciation and other auto expenses, so you would not need to track these expenses.
A note about the use of the auto expense. In your first year, if you choose to use the actual expense method, you will not be able to use the Standard Millage Rate in the future. Meaning, you must stick with the Actual Expense Method. However, if you use the Standard Millage Rate in the first year, you could switch back and forth in the years to come.
As a business owner you are familiar with many of the expenses that comes with business ownership. However, educating yourself about the potential tax deductions can help you to reduce your tax burden. Just make sure you are using them correctly to avoid audits. Remember, when you aren’t sure about a deduction reach out to your trusted advisors. They are there to help guide you so that you can focus more of your time on making your small business as successful as possible.
Please note, Castle Wealth Advisors, LLC is not a tax advisor. All decisions regarding the tax implications of your investments should be made in consultation with your independent tax advisor.
Castle Wealth Advisors, LLC does not provide tax or legal advice. We will work with your independent tax/legal advisor to help create a plan tailored to your specific needs.
This material is not intended to replace the advice of a qualified tax advisor, attorney, and accountant or insurance advisor. Consultation with the appropriate professional should be done before any financial commitments regarding the issues related to the situation are made.
The material contained herein is for informational purposes only and does not constitute tax advice. Investors should consult with their own tax advisor or attorney with regard to their prices and yields will fluctuate.