In our January newsletter, we spoke a little bit about some of the more common income items you might find on your personal or business tax returns. Most of what we discussed was fairly straightforward, but we did leave you dangling with the words, "... expenses applicable to your business are deductible on Schedule C and we will discuss them at a later point in time."
Well, guess what; now is the time and we're ready to discuss those business expenses. So, let's get started.
We might as well start this month's article off with a retraction. In our January article, we said, "All expenses applicable to your business are deductible on Schedule C..." That's not technically true. Here are a few things that are not deductible on Schedule C:
- Most meal and entertainment expenditures are not fully deductible. Generally, you can only deduct 50% of these costs unless 1) the meals are essentially de minimis fringe benefits to employees that would be included on their W-2 except the amount is so small, accounting for it is not sane or 2) the expense is incurred in the course of providing products or services to a customer and you bill the customer directly for the cost of the meal. If one of the two exceptions is met, then 100% of the meal cost is deductible.
- Health insurance for you and your family is not deductible on the Schedule C or F; however, it is deductible on page 1 of Form 1040. You may ask what difference this makes. Well, the answer depends on how much you make. Let's assume for the sake of argument that you net $75,000 on your Schedule C before accounting for the cost of your health insurance. If you could deduct the $1,400 per month you pay in health insurance, your Schedule C income would be reduced by $16,800, which means your self-employment income would be reduced by $16,800. This would save you $2,373 in self-employment taxes. What a difference a schedule makes!
- You may have been required to obtain life insurance as an added comfort for the bank that holds the note on your five company jets. Don't even think about deducting the $25,000 in life insurance premiums you pay. These are considered personal and will not be deductible despite the fact that you were basically forced to get the insurance as a condition of financing.
Ok, now that we know what is not deductible, let's take a deeper look at your Schedules C and F.
The first thing you notice when you look at the Form 1040, Schedule C or Schedule F is that there are a lot of potential deductions. Not including the Cost of Goods Sold line (Line 4) there are 19 items that are specifically named on Schedule C and 22 items on Schedule F. That's not surprising when you stop to think how many different checks you may write during any given month.
Most of the items on Schedule C are self-explanatory. Advertising, Commissions, Travel, Taxes and Licenses, Utilities, Wages, Legal and Professional Fees and Insurance are pretty much identifiable expenses if you have them, especially the Wages expense.
Other expenses may need a little explanation. For example, what is that depletion stuff on Line 12? Chances are you probably won't run into depletion unless you operate in a mineral industry like oil & gas production; however, for future reference, depletion is supposedly a way to recoup the money invested in properties that have a definite production life. An oil well only has so much oil; timberland only has so much timber and so on. The rules can get complicated on how much depletion you are allowed and we won't go into them here, but suffice it to say that if you have income from a property that comes from extracting "something" from Mother Earth, you may have some form of depletion deduction - don't forget about it.
Most business owners are familiar with depreciation. What we want you to remember here is Congress gave you the ability to immediately expense up to $100,000 in otherwise depreciable assets in the year you purchase them. There are certain catches to the rule, not the least of which is the income limitation. You can only deduct an amount that is equal to or less than your earned income. To get to this number, you first determine the income or loss from your business. If the cost of the property to be expensed is equal to or less than your business income, you can basically deduct the whole amount up to $100,000. You can include in the "business income" amount salary income. Say you lost money on your farm or business, but you had a $300,000 salary. If youÂ’re operating as a sole proprietor, you can treat that salary as business income and continue to deduct up to $100,000. Many times the rules read as if you can only deduct the equipment expense against the business in which the equipment is used. This is not true if you are operating as a sole proprietor.
Don't forget that you also will have the ability to take an additional 50% (30% for assets acquired before May 6, 2003) in "bonus" depreciation in the year of purchase for other assets purchased in 2003. The kicker here is that the equipment must be new. You can't get the added depreciation on used equipment you purchase.
Line 14 of Schedule C (line 17 on Schedule F) is titled "Employee benefit programs..." This is where you would include the cost of health insurance for your employees, but not yourself. Other examples of expenses you may include here are group term life insurance and the cost of dependent care expenses and cafeteria plan expenses. Do not include on this line expenses related to employee retirement plans.
Now a word or two about car and truck expenses (Line 9 on Schedule C and Line 12 on Schedule F). What you report here is, in large measure, determined on how you do business. If you simply have one automobile you use to make sales calls, the process is fairly simple. In this case, you will have a choice between using actual costs and depreciation or using the standard mileage rate. In either event, you will have to keep a log of the date, beginning and ending mileage and business mileage for your vehicle.
The standard mileage rate for 2003 is 36 cents per mile. This includes all costs, except for interest on loans used to purchase the vehicle. If you choose to use the standard mileage rate for auto expenses, you will be allowed an expense equal to the business miles driven multiplied by the standard rate plus any interest expense attributable to the business portion of the automobile. The advantage to using the standard mileage rate is that record keeping is simplified.
On the other hand, should you choose to use the actual expenses, you need to keep detailed records of all expenses related to the operation of your automobile. This includes mileage records, interest, gas, insurance and repairs. You would then allocate the total expenses, including depreciation, to business based on business miles driven divided by total miles driven. While this may entail greater record keeping, if you have a vehicle with high maintenance costs, you may come out better using actual costs rather than the standard rate.
You cannot use the standard mileage rate to determine the deductible expense of two or more vehicles used simultaneously. This rule changes in 2004 to allow you to use the standard rate for up to four automobiles used at one time.
Don't forget you still have the ability to establish a Simplified Employee Pension plan sometime before you file your tax return and you may have the ability to claim a home office deduction. A SEP can be set up and funded even in 2004 under certain conditions, but you need to weigh the tax savings and benefits to your own retirement planning with the cost of funding an employee's retirement. If you used a room in your home strictly for business purposes, you may be able to deduct costs related to that room. Rules are tricky in these areas, so let's talk before you sign your return.</>
While there are many other expenses you might be able to deduct on either Schedule C or F, space limits us to discussing only a few. Given the wide range of items that could be deductible, don't shortchange yourself and pay more tax than you should. Give us a call today so we can work together to minimize what you pay in income and self-employment taxes.
Have a great February and keep our troops in your thoughts and prayers.