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FOR THE LOVE OF MONEY: Everybody Needs to Mind Their Business.
While you were sleeping, Congress passed new laws regarding your money. Over the next few weeks, this column will explore how these new laws can help put and keep more money in your pocket. Up this week, is the 4-1-1 on special treatment of expenses for Small Businesses.
Let's face it. If you "Wanna Get Paid," (LL Cool J, 1997), and you're going through life trying to make your money only through a "9 to 5," you'll have a hard time accumulating wealth. You must look at building net worth. Having your own business is one of the best ways to accomplish this. According to the U.S. Small Business Administration, there are more than 22.9 million small businesses. Many of these small businesses are started by people who also have "day jobs."
Small businesses range in all shapes and sizes. From selling Avon™ and Mary Kay™, to opening up a small catering company, consulting business or selling on Ebay™. In fact, many people have side businesses and they don't even know it. If you receive a tax Form 1099, because you are a consultant, you are in fact a sole proprietorship and I welcome you to the land of the "side business." Even if you get all your money in cash from braiding hair at your house, selling sodas at the little league game or hooking up haircuts in the dormitory, you are still operating a sole proprietorship. Also, for people who have established partnerships, corporations or limited liability companies, these too can qualify as small businesses.
No matter what the type, you are required to report all income from your side business to the IRS. Most folks with a small business will consider this a hindrance, especially if they are paid in cash. But many new small businesses will actually be operating at a loss during the early years. And this loss can be deducted against their 9 to 5 day job income! So by not filing, you're actually leaving money on the table. If you report your income and deduct all your expenses, you may just walk away with an even larger tax refund.
How does this happen? Because there are many expenses that can be deducted, such as advertising, office supplies, equipment, travel, automobiles, meals, health insurance and utilities. You will also buy many business assets, especially during the early years. Things like computers, furniture, fax machines, and mobile phone/personal organizer combos are just a few essential assets that every small business owner might have.
It might appear that as a small business owner you can deduct everything, right? "Hold On," (En Vogue, 1990)…not so fast! Did you know that you may not be able to take a tax deduction for the entire amount you spend on your business assets; at least not all at once? Your business assets are thought to benefit your business for longer than just the first year in which you purchase them. In tax talk, this is called the useful life. The thinking is, these assets will have a useful life for many future years ( i.e., five for many business assets). Any tax deduction for this asset should match the years in which it was useful. So, you can only deduct the portion of the asset's cost in the year in which you purchased it. The rest is spread out ( i.e., depreciated) over the remaining useful life (i.e. five years).
Here's where Congress has stepped in to save the day. The Tax Increase Prevention and Reconciliation Act, which was passed on May 11, 2006, extends a special tax exception for small businesses (i.e., those businesses making less than around $430,000). Now, you may be able to take a current tax deduction for most of your business assets in the year in which you purchase them. This means for 2006, you can write-off up to $108,000 of your business assets.
So thanks to this new law, your new $1,000 lap-top computer can be fully deducted in the year that it was purchased. Why is the new law so generous? This exception is trying to provide an incentive to help businesses prosper. Expensing can provide both the cash flow and the tax break to make asset purchases possible and feasible for many small businesses. Of course there are a few rules and exceptions to the rule you must keep in mind:
First, the asset must be used by you in your business for more than 50% of the time. This means your personal use of the asset cannot be greater than 50%. But this is only part of the test. You must then back out your personal usage from the cost of the asset to come up with your actual deduction. So, if you buy a 1,000 lap-top, but use it for personal reasons for 40% of the time, you can only deduct $600 ($1,000 - $400). Finally, you can only deduct up to $108,000 total, for the entire year. Any amount over that must be depreciated.
So if you're still singing, "Where the Party At," (Jagged Edge, Featuring Nelly, 2001), it's time to turn this curiosity into a money-making venture and throw parties on the side. Even if you have a full time job, you can still open a side business and use expenses from that business to offset your income.
Shannon King Nash is the author of the award-winning book entitled, "For the Love of Money: The 411 to Taking Control of Your Taxes and Building Your Net Worth." She uses song lyrics and entertaining stories ripped from the headlines to teach readers how to manage their finances and taxes. Shannon is a CPA, Tax Attorney, and regular expert commentator on KJLH FM Radio in Los Angeles, and has appeared on national television. To learn more about Shannon King Nash and "For the Love of Money" visit www.nashgroup-usa.com
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