Preface: Accurate tax preparation begins with good record keeping. Small business owners often neglect this area of operations. This blog outlines a few of the reasons why investing in good record keeping is worth the effort.
Small Business Tax Record Keeping and Home Office Deductions
Small business owners should always keep good financials records. This applies to all businesses, whether they have a couple dozen employees or just a few. Whether you install software or make soft-serve. Whether they cut hair or cut lawns. Keeping good records is an important part of running a successful business. Here are some questions and answers to help business owners understand the ins and outs of good recordkeeping.
Why should business owners keep records?
Good records will help you as a business owner:
- Monitor the progress of business financial performance;
- Prepare financial statements for banks, creditors, and management;
- Identify concentrations of income sources;
- Keep track of expenses and assist with budgeting;
- More accurate tax returns and support items reported on tax returns;
What kinds of records should you keep?
Small business owners may choose any recordkeeping system that fits their business. They should choose one that clearly shows income and expenses. Except in a few cases, the law does not require special kinds of records. QuickBooks is a good choice for many small businesses.
How long should your business keep financials records?
How long a document should be kept depends on several factors. These factors include the action, expense and event recorded in the document. The IRS generally suggests taxpayers keep records for three years.
How should your business record transactions?
A good recordkeeping system includes a summary of all business transactions. For beginners, these are usually kept in books called journals and ledgers, which business owners can buy at an office supply store. All requirements that apply to hard copy books and records also apply to electronic business records.
What is the burden of proof?
The responsibility to validate information on tax returns is known as the burden of proof. Small business owners must be able to prove expenses to deduct them.
How long should businesses keep employment tax records?
Business owners should keep all records of employment taxes for at least seven years.
Tax Deduction for Home Office
Taxpayers who use their home for business may be eligible to claim a home office deduction. It allows qualifying taxpayers to deduct certain home expenses on their tax return. This can reduce the amount of the taxpayer’s taxable income. Here are some things to help taxpayers understand the home office deduction and whether they can claim it:
- The home office deduction is available to both homeowners and renters.
- There are certain expenses taxpayers can deduct. They include mortgage interest, insurance, utilities, repairs, maintenance, depreciation, and rent.
- Taxpayers must meet specific requirements to claim home expenses as a deduction. Even then, the deductible amount of these types of expenses may be limited.
The term “home” for purposes of this deduction:
Includes a house, apartment, condominium, mobile home, boat or similar property. Yes, you can work from a boat in the “Roaring 20’s.”
Also, ” home” includes structures on the property. These are places like an unattached garage, studio, barn or greenhouse, or work ship on the water.
“Home” doesn’t include any part of the taxpayer’s property used exclusively as a hotel, motel, inn or similar business.
There are two basic requirements for the taxpayer’s home to qualify as a deduction:
- There must be exclusive use of a portion of the home for conducting business on a regularly basis. For example, a taxpayer who uses an extra room to run their business can take a home office deduction only for that extra room so long as it is used both regularly and exclusively in the business.
- The home must be the taxpayer’s principal place of business. A taxpayer can also meet this requirement if administrative or management activities are conducted at the home and there is no other location to perform these duties. Therefore, someone who conducts business outside of their home, but also uses their home to conduct business may still qualify for a home office deduction.
Expenses that relate to a separate structure not attached to the home will qualify for a home office deduction. It will qualify only if the structure is used exclusively and regularly for business.
Taxpayers who qualify may choose one of two methods to calculate their home office expense deduction:
The simplified option has a rate of $5 a square foot for business use of the home. The maximum size for this option is 300 square feet. The maximum deduction under this method is $1,500.
When using the regular method, deductions for a home office are based on the percentage of the home devoted to business use. Taxpayers who use a whole room or part of a room for conducting their business need to figure out the percentage of the home used for business activities to deduct indirect expenses. Direct expenses are deducted in full.
If you would like to discuss tax planning opportunities, small business record keeping, or understand the ways in which you can use your home regularly and exclusively for your business to reduce your tax bill, please call our office at your earliest convenience.