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"There's nothing wrong with the younger generation that becoming taxpayers won't cure."
— Dan Bennett
T
he home-based business (a.k.a., small business) is one of but a few legal tax
shelters that remain in the U.S. What does that mean for
taxpayers? To answer this question we need to understand this: we have in this country
two tax systems! Most likely, the majority of people would say that
there is one tax system for the rich and one for the poor. In reality, though, this assumption has
more to do with a political myth meant to divert attention from the real situation. In the U.S.,
there exists one tax system for employees — those who work for someone else —
that is designed to confiscate wages and earnings! As an employee, you pay
taxes on virtually everything, with no relief to be found anywhere in the tax code. There is
another tax system — for self-employed people — that is specifically designed to
reward small business creation and promote economic growth. The reason for this reward
system is that small businesses generate more than 70 percent of the new jobs in this
country. Thus, Congress — whose members face re-election by these job creators —
has passed a number of beneficial tax laws: good tax laws for small businesses.
Let's consider a few brief examples. As an employee earning $60,000 a year, you and your
employer must pay Social Security Taxes that total 15.3 percent of your $60,000 earnings. Obviously,
you also must pay income tax on that $60,000, regardless of whether or
not you have business expenses related to your employment. However, if you are self-employed,
and for the sake of illustration have $30,000 of expenses set against that
$60,000 income, you pay Social Security and Income Taxes on only
$30,000. If your home business were to generate financial losses, and those losses were to exceed
the income from that business, you could then subtract those losses from any
other form of income you might have. These other forms of income can include your spouse's income,
interest; dividends; rents; wages; pensions; anything.
But, what if your business losses should exceed your entire income? In this case you have two
additional options. First, you can carry back all business
losses incurred for two years! Thus, you can actually get a
tax refund from the last two years' worth of federal and state income taxes
paid. Alternatively, you can carry forward all business losses for the next 20 years
and offset the next 20 years of earnings. In other words, you virtually never lose out on
those business deductions that are properly documented.
You say that your home-based business enjoys profits rather
than losses? Terrific, you can still save on your taxes!
By running a profitable home-based business, you can set up a multitude of fringe
benefits, many of which are discussed at length in the tax
reduction strategy outlined in Sandy Botkin's audio course. You can set up for your
business a self-insured medical reimbursement plan and write off:
all your deductibles; your eyeglasses; your co-insurance; and pre-existing conditions.
Usually, the cost of these items must exceed a certain threshold — 7.5 percent of your adjusted
gross income — for you to be able to deduct anything. But, by instituting a
self-insured medical reimbursement plan, you not only get this deduction — it's dollar-for-dollar.
How else might these good tax laws benefit you? If you have a child and want
to send him or her to college, is that deductible? If you pay for your
daughter’s wedding, is that deductible? The answer to both
questions is no . . . BUT, if you were to hire your
child (or children) to work in your business and then pay them
the same wage that you would pay an assistant, that IS
deductible! If they then turn around and use the money
you paid them to pay for their own college or their own
wedding or their own car, aren't you in essence getting a deduction
for those things? In addition, children under the age of 18 — if you were to hire them in
a sole proprietorship business — are exempt from Social Security and
federal unemployment taxes. Moreover, the first $4,700
they earned in 2004 would be exempt from income tax. Thus, you get a tax deduction
and your children earn money tax-free.
To protect yourself, in the above situations of hiring your
children it is essential that you have a record of
what they did, when they did it, and how long they worked. You also need to pay them by
check. Checks establish a payment
trail from you, to your child, to your child's bank account. You should also have a
contract-for-services that show you hired your children and show
what you paid them — a normal contract like any other employee.
All of this also applies when you hire your spouse, as well. As noted above,
you can also set up a self-insured medical reimbursement plan. In this way, you can deduct
all of your medical expenses — again, dollar-for-dollar —
because you’re providing a medical reimbursement plan for your
employee, who you also happen to be married to. The IRS has approved this,
by the way: it’s not some made-up loophole.
Want additional legitimate deduction information? Most people don't know that when you're in
business, there are ways that you can also deduct your fun. IRS regulations say that
you can deduct both 50 percent of your own fun and 50 percent of
your business associate's fun — so long as you talk business with
them within the same 24-hour day. For instance, let’s say you
invite a prospect to go to a football game with you. You talk about business with
him over the phone and then pick him up for the game two hours
later. In this scenario you have talked business and “had fun” (with the same individual, of
course) within the same 24-hour day. Let’s say you and I go to a
restaurant, we talk in the car about exchanging business referrals,
and then we go to a nice theater. That is talking business
with my dinner/theater mate (you) within the same 24-hour day.
This entertainment deduction is made better by the fact that
you don't need receipts for entertainment that costs under $75 per expense. When
you do entertain, however, the IRS requires certain
documentation. With the entertainment
examples we’ve talked about, you must write down what we might call
“the four W’s and an H.” These are:
Who: Name and occupation.
Where: We went to Happy Pappy’s Steak House.
Why: Why did you take that person out? (One of the biggest mistakes
self-employed people make is to not be specific about “Why.” Writing down the word
"prospect" isn't specific enough. Writing "good will" isn't
specific enough. Specific would be "I tried to
get a referral" or "I talked with a reporter about my book." Don't be general.)
What: What was the date and was it for breakfast, lunch, dinner, etc?
How much: How much did it all cost?
If you write down all five of these things, you'll never have to worry about an IRS income tax
audit again. Be warned, however, if you leave out any one of these five items, your
business deductions will be disallowed and the IRS will thump you with a 75
percent penalty, plus interest.
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