Protect your business with meticulous records
If you run a business, you know that you need to support expenses with detailed records. To be deductible, every expense on your tax return might have to be defended if your company is subject to an audit. Plus, failing to operate in a businesslike manner, complete with good records, might lead the IRS to deem the activity a hobby rather than a business — and your expenses may be limited or disallowed.
While there’s no one right way to keep business records, some types of expenses do require more details. For example, records relating to automobile expenses, travel, meals and office-at-home costs are subject to special requirements or limitations.
To claim deductions, an activity must be engaged in for profit
For a business expense to be deductible, the taxpayer must establish that the primary objective of the activity is making a profit. The expense must also be substantiated and be an “ordinary and necessary” business expense. In one court case (Gaston v. IRS, 2021), a taxpayer claimed deductions that created a loss, which she used to shelter other income from tax.
She engaged in various activities that included acting in the entertainment industry and selling jewelry. The IRS found her activities were more like hobbies than businesses engaged in for profit and it disallowed her deductions.
The taxpayer did, however, have some success when she took her case to the U.S. Tax Court. The court found that she was engaged in the business of acting for profit during the years at issue, though not all of the claimed expenses were ordinary and necessary business expenses. The court allowed deductions for expenses including headshots, casting agency fees and lessons to enhance the taxpayer’s acting skills. But the court disallowed other deductions because it found insufficient evidence “to firmly establish a connection” between the expenses and the business.
In addition, the court found that that taxpayer didn’t prove that she engaged in her jewelry sales activity for profit. She didn’t operate it in a businesslike manner, spend sufficient time on it or seek out expertise in the jewelry industry. Therefore, all deductions related to that activity were disallowed.
We can help
Contact us if you need assistance retaining adequate business records. Taking a meticulous, proactive approach can protect your deductions and prevent the IRS from viewing your business as a hobby.
Proper records are required
In another case, a taxpayer worked as a contract emergency room doctor at a medical center. He also started a business to provide emergency room physicians overseas. On Schedule C of his tax return, he deducted expenses related to his home office, travel, driving, continuing education, cost of goods sold and interest. The IRS disallowed most of the deductions.
In U.S. Tax Court, the doctor used charts to illustrate his expenses but didn’t provide receipts or other substantiation showing the expenses were actually paid. He also failed to account for the portion of expenses attributable to personal activity.
The court disallowed the deductions, stating that his charts weren’t enough and didn’t substantiate that the expenses were ordinary and necessary in his business. It noted that “even an otherwise deductible expense may be denied without sufficient substantiation.” The doctor also didn’t qualify to take home office deductions because he didn’t prove it was his principal place of business. (Elbasha v. IRS, 2022)
Qualifying for the home office deduction
In recent years, many people have pivoted to working from home, and that brings up tax questions. If you’re one of those people, you might wonder, “Can I claim the home office deduction on my 2022 tax return?”
The short answer is: only if you’re self-employed. Employees can’t currently claim home office expenses, and even self-employed taxpayers must follow strict rules to claim deductions.
If you qualify, you can deduct the “direct expenses” of a home office. This includes the costs of painting or repairing the home office and depreciation deductions for furniture and fixtures used there. You can also deduct the “indirect” expenses of maintaining the office. This includes the allocable share of utility costs, depreciation and insurance for your home, as well as the allocable share of mortgage interest, real estate taxes and casualty losses.
In addition, if your home office is your “principal place of business,” the eligible costs of traveling between your home office and other work locations are deductible transportation expenses, rather than nondeductible commuting costs.
Tests for deductibility
You can deduct your expenses if you meet any of these three tests:
- Principal place of business. You’re entitled to deductions if you use your home office, exclusively and regularly, as your principal place of business. Your home office is your principal place of business if it satisfies one of two tests. You satisfy the “management or administrative activities test” if you use your home office for administrative or management activities of your business, and you meet certain other requirements. You meet the “relative importance test” if your home office is the most important place where you conduct business, compared with all the other locations where you conduct that business.
- Meeting place. You’re entitled to home office deductions if you use your home office, exclusively and regularly, to meet or deal with patients, clients or customers. The patients, clients or customers must physically come to the office.
- Separate structure. You’re entitled to home office deductions for a home office, used exclusively and regularly for business, that’s located in a separate unattached structure on the same property as your home. For example, this could be in an unattached garage, artist’s studio or workshop.
You may also be able to deduct the expenses of certain storage space for storing inventory or product samples. If you’re in the business of selling products at retail or wholesale, and if your home is your sole fixed business location, you can deduct home expenses allocable to space that you use to store inventory or product samples.
Know the limitations
The amount of home office deductions for self-employed taxpayers is subject to various limitations. Proper planning is key to claiming the maximum deduction for your home office expenses. Contact us if you’d like to discuss your situation.
Moving out of state? Learn all the tax implications first
With so many people working remotely these days, it’s become common to think about moving to another state — perhaps for better weather or to be closer to family. Many retirees also look at an across-the-border move to better control living expenses. If you’ve found yourself harboring such notions, be sure to consider taxes before packing up your things.
What taxes apply?
It may seem like a no-brainer to simply move to a state with no personal income tax, but you must consider all taxes that can potentially apply to state residents. In addition to income taxes, these may include property taxes, sales taxes, and estate or inheritance taxes.
If the states you’re considering have an income tax, look at what types of income they tax. Some states, for example, don’t tax wages but do tax interest and dividends. And some states offer tax breaks for pension payments, retirement plan distributions and Social Security payments.
What are the domicile requirements?
If you make a permanent move to a new state and want to escape taxes in the state you came from, it’s important to establish legal domicile in the new location. Generally, your domicile is a fixed and permanent home location where you plan to return, even after periods of residing elsewhere.
Each state has its own rules regarding domicile. You don’t want to wind up in a worst-case scenario: Two states could claim you owe state income taxes if you established domicile in the new state but didn’t successfully terminate domicile in the old one. Additionally, if you die without clearly establishing domicile in just one state, both the old and new states may claim that your estate owes income taxes and any state estate tax due.
The simplest and most obvious way to establish domicile is to buy or lease a home in the new state and sell your previous home (or rent it out at market rates to an unrelated party). Then, change your mailing address on passports, insurance policies and other important documents. Getting a driver’s license in the new state and registering your vehicle there also helps. Be sure to take these and other steps as soon as possible after moving.
When looking into whether the grass is greener in another state, do some research and contact us. We can help you avoid unpleasant tax surprises.
Throwing snowballs at a mountain of debt
Many people start the year intending to get out of debt, yet end the year owing just as much, if not more. One approach that might yield success is called “throwing snowballs.”
Under this method, you organize your debts from the lowest balance to the highest balance and begin paying off the debt on top of the list. The idea is to throw as many “snowballs” as you can at that first creditor until the debt is gone.
While you hurl these snowballs, pay the minimum amount to your other creditors. With this strategy, you should avoid trying to send an extra $20 or so a month to each one. If you want to contribute extra money, throw it at your primary target.
Once the first debt is paid off, you should have even more money to send to the next one. Over time, you can start heaving bigger and bigger snowballs at the remaining targets because, as you pay off each debt, you’ll have more money to pay toward remaining debts.
The objective is to start an avalanche of payoffs until your debts disappear. Under this method, the best predictor of success isn’t the number of dollars you pay off but rather the number of accounts that you close.
Please note: There’s some debate on the practicality of throwing snowballs. Opponents argue that you should first pay off debts with the highest interest rates. We can help you plan a debt-reduction strategy that’s right for you.
February 28 – Employers must file 2022 Form 1099-MISC (“Miscellaneous Income”) reporting certain payments to certain persons, along with the related Form 1096 (“Annual Summary and Transmittal of U.S. Information Returns”), and provide copies to recipients.
March 15 – Calendar-year partnerships and S corporations must file or extend 2022 tax returns. If the return is not extended, this is also the last day for those types of entities to make 2022 contributions to pension and profit-sharing plans.
About Batley CPA
Batley CPA, LLC is a full-service CPA firm providing tax, accounting, payroll and advisory services to businesses and individuals throughout Green Bay and the Fox Cities. Batley CPA regularly provides clients with best practices and strategies to maximize cash flow, profit, reduce taxes, manage costs and risk, and bring meaning to financial and operational data. The company has offices in Appleton, Neenah and Green Bay.