Top 10 Home Business Tax Tips

It is said so often that it has become a bit of a cliche, but one of the great virtues of starting a home business are the tax breaks you can claim. Another popular belief surrounding home businesses, however, is that claiming aggressive - and maybe slightly exaggerated - write-offs is a sure-fire way to attract IRS auditors. In this article, we'll look at some of the more popular home business write-offs as well as some tips on how you can legitimately claim them. (Homebodies can save big on their tax bill. Learn how to get in on the action. Check out How To Qualify For The Home-Office Tax Deduction.)

TUTORIAL: Starting A Small Business

1. Keep a Business Journal
Being audited is not the end of the world. However, being audited and not having the records to back up your deductions can be a nightmare. The simplest way to avoid this unpleasant situation is to keep a daily log of your home business activities. Did you buy paper for the printer in your office? Write it down and either attach the receipt to the page in the case of a hardcopy or scan the receipt in if you are keeping a digital log. The same goes for mileage, phone calls and other costs, as well as payments received by your business.

The more detailed your accounts are, the easier it will be to face an audit. Compiling your daily reports into a monthly tracking sheet will drastically shorten the time it takes you to get your taxes together, and it will have the added benefit of providing a snapshot of your business month-to-month.

2. Write-Off Your Workspace
Writing off a home office can be particularly attractive if you have a line of work that can be neatly confined to a dedicated room. You can still write off part of a shared room, but in either case, the space is calculated as a percentage of the total house or apartment area. That percentage is applied to all the related costs, including utilities, insurance, rent or mortgage payments and so on. Do not claim unrelated expense like the installation of a bird fountain in the backyard - those types of stretches make IRS auditors a little testy. (Your work environment can make or break your career as an entrepreneur. To learn more, read Creating A Home Business Work Space.)

3. Update Your Equipment
Office furniture, software, computers and other equipment are all 100% deductible within the year that the cost is incurred - you don't need to depreciate. There is an upper limit and the purchases must be majority-usage (primarily used) and necessary or helpful for business. Within those generous guidelines, however, you should have no problem keeping current. However, a widescreen TV and La-Z-Boy for the office is going to be a hard sell.

4. Save for Retirement, Stay Healthy
If you are working solely for your home business, you will have to pay the employer's share of Social Security and health insurance, but you can deduct half the amount of social security and the total premiums for you and any employees (more on that later). You can also fund retirement plans designed for the self-employed - SEP-IRA, Keogh plans, etc. - and write the contributions off against your personal income tax.

5. Talk Up a Storm
If chatting with clients is a necessary (or helpful) part of your business, it may be worth getting a second phone line or a dedicated business cell phone, as both of these are 100% deductible. If you only converse with clients occasionally, you can still write off the costs by noting the dates, times and reasons for the calls and then circling the items on your regular phone bill to deduct at tax time.

6. Get Connected
Similar to the phone bill, you can deduct part of the cost of your internet if you use it for business. There is no absolute percentage to use, but it will be difficult to write off more than 50% if other members of your family are using it for non-business purposes. Be reasonable and pick a defensible percentage that you won't regret in the case of an audit. (Running your own business has both personal and financial perks. See 10 Tax Benefits For The Self-Employed.)

7. Entertain Us
You can wine and dine clients - emphasis on clients (preferably paying or likely to pay clients) - and get a tax break. The tendency for business owners at all levels to abuse this write-off has scared many home business owners away from claiming it. However, it is acceptable for you to take out a client for a meal and some entertainment. It will be easier to defend a $200 deduction for a client who has brought you a lot of business than the same meal for a buddy who paid you $20 for an hour's work over the entire fiscal year.

8. Take a Trip, Not a Vacation
Have to hit the road to expand your market? Save your receipts. On business trips, your travel expenses are 100% deductible and your food expenses can be deducted at 50% of the total. Keep all of your receipts because even things like dry cleaning and tips are considered a necessary expense when you're out pounding the pavement in new markets.

Your local day-to-day mileage incurred for business purposes can be written off as well, so give the same attention to tracking your mileage on smaller trips that you would to the expenses of an overnight trip. For many people, the mileage deduction is the more realistic deduction than first class tickets to New York. Remember, you have to be able to justify any trip and preferably show the payoff to your business resulting from it.

9. Employ (Not Just Pay) Your Family
You can use family members as employees and deduct their salaries as long as you account for their work and pay the going rate. If you have a business that lends itself to having a spouse and kids help out, then use that labor pool. You'll likely pay less than market rates for the help, and you can deduct insurance premiums for them as well. As an added bonus, children under the age of 17 don't incur the Social Security tax, but they can still make contributions to a Roth IRA - so you can teach them work ethic and saving habits in one go.

10. Make Justifiable Deductions
The most important tip has been a theme throughout, but it is worth repeating: just because you have a home business doesn't mean you can go crazy with deductions. If you don't think you can face down an auditor with detailed proofs justifying the deduction, then perhaps it isn't a deduction you should be taking. (Keeping thorough records and knowing the penalties make this experience easier than you'd expect. For additional reading, refer to Surviving The IRS Audit.)

The Bottom Line
A home business can be a rewarding experience, both for the extra income it can bring in and the tax breaks it yields. A complete read through the IRS small business publications is well worth your time. You will learn more about the deductions mentioned here and what conditions need to be met to claim them. Although it is important to keep accurate records and stick to deductions you can justify, it is also in your interest to maximize your deductions as much as you can while staying within the rules. The IRS guides are not nearly as difficult as they are made out to be, but if you still feel adrift after reading them, then finding a good business accountant will save you time and hopefully a lot of money.

by Andrew Beattie (Contact Author | Biography)

Andrew Beattie is a managing editor and contributor at Investopedia.com.

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Shadow Market

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Minimize Taxes With Asset Location

Asset location is a tax minimization strategy that takes advantage of the fact that different types of investments get different tax treatments. Using this strategy, an investor determines which securities should be held in tax-deferred accounts and which securities should be held in taxable accounts in order to maximize after-tax returns. This article will explain who can benefit from this investment strategy, how asset location minimizes taxes and the optimal way to locate assets.??

Tutorial: Personal Tax Guide

Who Benefits from Asset Location?
For investors to benefit from this strategy, they must have investments in both taxable and tax-deferred accounts. Investors with assets split between taxable and nontaxable accounts and with similar asset mixes will get the largest benefit from asset location. For example, an investor with an asset mix of 40% fixed income and 60% equity will achieve the maximum benefit if?the tax-deferred account holds 40% and?the taxable accounts holds 60% of total assets. In this case, moving all fixed-income investments into?the nontaxable account and all equities into the taxable account will provide the maximum benefit.

Typically, investors who use a balanced investment strategy consisting of equity and fixed-income investments can get the most benefit from asset location. However, investors with all fixed-income or all-equity portfolios can still benefit, albeit not to the same degree.

If an investor is withdrawing funds from tax-deferred accounts or will be doing so in the near future, the benefit of an asset location strategy is greater than it would be for younger investors with many years left before they will start withdrawing funds. As an example, assume an investor made $20,000 in capital gains and dividends in?a Traditional IRA during the past year and withdrew the same amount. At the top tax bracket, these earnings would be taxed at 35%, leaving the investor with $13,000. If the investor made $20,000 in capital gains and dividends in a taxable account, the tax would have been only 15%, leaving $17,000. (For related reading, see Not All Retirement Accounts Should Be Tax Deferred.)

How Asset Location Minimizes Taxes
A typical investor with a balanced portfolio consisting of 60% stocks and 40% bonds might hold investments in both taxable accounts and tax-deferred accounts. Although the investor's overall portfolio should be balanced, each account does not need to have the same asset mix. Creating the same asset allocation in each account ignores the tax benefit of properly placing securities in the type of account that will assure the best after-tax return.

How a security is taxed will determine where it should be located. Under the 2010 tax code,?dividends and capital gains get favorable treatment. While interest income gets taxed at a 35% rate for investors in the highest tax bracket, the tax rate for dividends and capital gains is only 15%. Since most equity investments generate returns from both dividends and capital gains, investors realize lower tax bills when holding stocks or equity mutual funds within a taxable account. Those same capital gains and dividends, however, would be taxed at the ordinary rate (up to 35%) if withdrawn from a traditional IRA, 401(k), 403(b), or other type of retirement account where taxes are paid on the withdrawal of funds.

Fixed-income investments, such as bonds and?real estate investment trusts (REITs) generate a regular cash flow. In 2010, these interest payments are subject to the same ordinary income tax rates of up to 35%. A tax-deferred retirement account provides investors with a shelter for this income. (For related reading, see Using Tax Lots: A Way To Minimize Taxes.)

Achieving Optimal Asset Location
Asset location, although it provides for lower taxes, is not a replacement for asset allocation. Only after you determine the proper asset mix for your portfolio can you then locate those investments in the appropriate accounts to minimize the tax drag on your investments. (For more information, see Choose Your Own Asset Allocation Adventure and Five Things To Know About Asset Allocation.)

The best location for an investor's assets depends on a number of different factors including financial profile, prevailing tax laws, investment holding periods, and the tax and return characteristics of the underlying securities. However, there are some general principles for the types of investments that are best-suited to each type of account.

Taxable Accounts
Tax-friendly stocks should be held in taxable accounts because of their lower capital gains and dividend tax rates and the ability to defer gains. Riskier and more volatile investments belong in taxable accounts both because of the ability to defer taxes and the ability to capture tax losses on poorly performing investments sold at a recognized loss. Index funds, as well as?exchange-traded funds (ETFs), are valued for their tax efficiency and should also be held in taxable accounts, as should tax-free or tax-deferred bonds. (For related reading, check out Selling Losing Securities For A Tax Advantage.)

Tax-Deferred Accounts
Taxable bonds, REITs and the related mutual funds should be held in tax-deferred accounts. Any mutual funds that generate high yearly capital gains distributions also belong in tax-deferred accounts.

Conclusion
Asset location is a strategy that determines the proper account to place investments in to get the most favorable tax treatment overall. It is not a replacement for asset allocation, but it adds to the overall after-tax return. The best location for a particular security depends on an investor's financial profile, prevailing tax laws, investment holding periods and the tax and return characteristics of the underlying securities.

by Ken Hawkins (Contact Author | Biography)

Ken Hawkins is the founder of Ohow Investor Consultants, www.ohow.ca, a private investment office set up to help investors manage their portfolios by providing custom-made investment solutions to meet each client's unique requirements.

Hawkins is also co-author of "The New Rules for Retirement - What Your Financial Advisor Isn't Telling You" (2008). He currently lives in Toronto, Ontario.

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4 Alternatives To Traditional Mutual Funds

The first generation of mutual funds began to impress their existence upon the public consciousness in the early 1970s. These open-ended vehicles became widely used by both individual and institutional investors to fund retirement plans, provide current income and diversify small portfolios. But the 1990s saw the advent of several new types of funds that were more streamlined, liquid and efficient than traditional open-ended funds. This article explores several reasons why the traditional open-ended mutual fund may be losing its relevance. (For related reading, also check out How To Pick A Good Mutual Fund.)

TUTORIAL: Mutual Fund Basics

Cost Disadvantages
Although the first generation of mutual funds has helped millions of Americans achieve their financial goals, they also have several substantial disadvantages, such as high costs and illiquidity. Many?A-share mutual funds carry initial sales charges as high as 5.75% and charge annual 12b-1 fees as high as 1%.?B-shares can have back-end sales charge schedules that gradually decline the longer you hold your shares and C shares typically do not have initial sales charges but can charge a back-end load if the shares are sold within a short time frame. The latter two share classes also typically have higher annual expenses than A shares. Obviously, this substantially reduces the return on capital to the investor, both in the short and the long term. (For more on fees, see The ABCs Of Mutual Fund Classes?and Stop Paying High Mutual Fund Fees.)

Example
John invests $100,000 in the A-share class of a growth fund. He pays an initial sales charge of 4.75%, thus reducing his initial principal to $95,250. The 12b-1 fees also reduce his average annual return of 8% per year to 7.25%. If John leaves his money in the fund for 20 years, the initial charge and lower annual return will reduce his overall savings by nearly $80,000.

Liquidity Disadvantages
Owners of open-ended mutual funds must also wait until the settlement date to get their money out of the fund. An investor who sells shares of a fund on Monday will not be able to take constructive receipt of the sale proceeds until Thursday of the same week,?at the earliest. For investors who need to access their money quickly for any reason, this can be a real problem.

Forward Pricing
Mutual fund prices also lag the markets on a daily basis. Because the portfolio managers trade securities within the portfolio on a daily basis, it is impossible for open-ended funds to post an intraday share price. They must instead use forward pricing, which is based on the daily closing prices of all of the securities within the portfolio.

Performance Disadvantages
This is perhaps the greatest disadvantage posed by open-ended funds. Although many funds have posted impressive returns over five- and?10-year periods, the average annual returns of virtually all stock funds have lagged those of the market itself over longer periods of time. As of 2010, only one mutual fund that has existed since 1970 has beaten the 10-year rolling return of the S&P 500 Index every single year. The rest have underperformed the markets as a whole, which has led to the popularity of index funds that simply invest directly in the S&P 500 or other index. (For more on index funds and how to invest in them, read The Lowdown On Index Funds.)

Taxation Disadvantages
Although taxation of any type of investment that is not housed inside a Roth IRA is inevitable, the taxation of open-ended mutual funds is especially inevitable. Open-ended mutual funds almost always pass on a pro-rata share of capital gains (and losses) distributions to shareholders once each year, typically in November. This means that any shareholder who owns shares in a taxable account will have gains or losses to report every year. These gains or losses may adversely affect the amount of income that the investor had planned on reporting that year.

Alternatives to Open-Ended Funds
Over the past 20 years, a plethora of alternatives to open-ended funds have arisen. Although some of these vehicles have become more popular than others, they all offer diversification and some degree of professional management without many of the shortcomings of open-ended funds. A list of these includes:

Unit Investment Trusts (UITs)
These instruments resemble mutual funds in that each unit of the trust represents a portion of each security that is held within the portfolio. However, they are more tax-efficient than actively managed funds, although they may post substantial gains or losses when the trust matures. (For more, see Investing In A Unit Investment Trust.) Variable Annuity Subaccounts?
These are essentially clones of taxable retail funds, but must be treated and reported as separate securities for regulatory reasons. Variable subaccounts have most of the same disadvantages as open-ended funds except that they do not post capital gains distributions. (For more, check out Subaccounts: As Good As Their Clone Funds?) Closed-End Mutual Funds
These funds have a limited number of shares than can be issued to investors. Once all of the shares are sold, the fund is closed to new investors and the shares begin trading in the secondary market. Exchange-Traded Funds (ETFs)?
Although this class of fund is still the new kid on the block, ETFs have quickly become very popular with serious investors for a number of reasons. As their name implies, these funds trade like stocks on the major exchanges and can be sold like any other security while the markets are open. They provide liquidity, diversity and some degree of professional management as well as tax efficiency in most cases. They can be ideal instruments for tax-loss harvesting. (For more on this topic, see ETFs Vs Index Funds: Quantifying The Differences.)

Bottom Line
Although there is still a huge market for open-ended mutual funds, their relative illiquidity, tax inefficiencies and subpar performance compared to their benchmark indexes over time have led to the creation of several more-efficient alternatives. Instruments such as ETFs and UITs are rapidly increasing in popularity and may eventually supplant their more traditional cousins.?

by Mark P. Cussen,CFPR, CMFC (Contact Author | Biography)

Mark P. Cussen has more than 15 years of experience in the financial industry, which includes working with investments, insurance, mortgages, taxes and financial planning. He has two years of experience in writing and editing insurance and securities test training manuals, as well as other financial topics. He has also worked in retail, discount and bank brokerage systems and been involved in a venture capital enterprise in the oil and gas sector. Cussen has a Bachelor of Science in English from the University of Kansas and completed his CFP coursework at the Bloch School of Business at the University of Missouri-Kansas City in August of 2001.

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Venoco To Plow The Monterey Shale In 2011 (VQ)

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