J. William Seabrooke CPA P.C.

The news media continues to report (with some variances) that our national unemployment rate is around 9.6%-9.8%.  This number is defined as those unemployed Americans who are actively seeking new employment.  By definition it excludes those persons who wish to work but have ended their search in frustration etc and those who lack the job skills demanded by the local job market.  In a nutshell, the “actual” unemployment rate is much higher than the “reported” rate.  For a myriad of reasons former employees may decide to start their own business rather than return to the work force.  If you are thinking along these lines then the information in this article may be of interest to you.

Although they are not all-inclusive (there are many more), the key points that I wish to present are:

• Business Form – among the first decisions to make is “What business form is best for my business?”  Among the choices are 1) Sole Proprietorship, 2) General Partnership, 3) Limited Partnership, 4) Corporation, 5) Sub-Chapter S Corporation, 6) Limited Liability Company (LLC), and 7) Limited Liability Partnership (LLP).  Important considerations include:  ease of formation, liability of the owners, management structure, transferability of ownership, and taxation.  Consult with an attorney who specializes in this area.  The legal fees are probably minute compared to the benefits that you will receive;
• Accounting Period and Methods – Is the calendar year best for your new business or is another 12-month period more appropriate?  Should you select the “Cash” basis for reporting revenue and expenses or is the “Accrual” method more appropriate?  Read through IRS Publication 538 (“Accounting Periods and Methods”) first and then consult with your CPA;
• Accounting Software – you must record all business transactions in a timely and consistent manner.  You also want to have several key financial reports (Balance Sheet, Profit and Loss, General Ledger etc) available to you regularly to determine 1) where you were, 2) where you are now, and 3) where you are going.   You’ll need also these reports for your supplies, customers, and vendors.  Your business will always be subject to “on-demand” audits by all of the taxing authorities and you must have records to support your reports.  Many very small business owners prefer QuickBooks for simplicity, ease of use, etc. Others prefer more sophisticated software such as Sage’s Peachtree.  There are also other packages that are available.  Consult with your CPA;
• Pricing Your Product or Service – failing to always have and know this information is almost a guarantee for your business to fail.  There are four components of every product and service: 1) direct material, 2) direct labor, 3) overhead (G&A), and 4) profit.  The value of each will be continuously changing every day that your business operates. Your accounting software will provide the information but you need to know how to extract the data.  If you use your Internet search engine, you’ll find that there is never a point in time or milestone in which a business can be assured of its longevity.  Any business can fail at any time, even if it has been in business for over 100 years.  Again, your CPA will be your best “quasi-business partner”;
• You Wear Many “Hats” – as the business owner, even though you may hire someone as the manager,  you are ultimately in charge of 1) Sales, 2) Marketing, 3) Human Resources, 4) Accounting, 5) Product/Service Development, 6) Logistics/Supply Chain Management, 7) Technical Support, and 8 ) Customer Service.  It’s a 24X7 responsibility!
• Continuously Increase Your Knowledge– regardless of the number of years that you have been in business you’ll never know all that you need to know.  Before you open the doors, read the following IRS publications from cover to cover: 334 – “Tax Guide for Small Businesses, 463 – “Travel, Entertainment, Gift & Car Expenses”, 535 “Business Expenses”, and if appropriate 587 “Business Use of the Home”.  Talk with other business owners who provide similar products and services.  Join a “network” of these owners or an association.  Identify colleagues who have the knowledge which you don’t have and consult with them regularly.  Find a mentor for your business.

The informaton below provides additional points to know and consider: 

Business Expenses

Business expenses are the cost of carrying on a trade or business. These expenses are usually deductible if the business is operated to make a profit.

□        What Can I Deduct?

To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.

It is important to separate business expenses from the following expenses:

• The expenses used to figure the cost of goods sold,
• Capital Expenses, and
• Personal Expenses.

□        Cost of Goods Sold

If your business manufactures products or purchases them for resale, you generally must value inventory at the beginning and end of each tax year to determine your cost of goods sold. Some of your expenses may be included in figuring the cost of goods sold. Cost of goods sold is deducted from your gross receipts to figure your gross profit for the year. If you include an expense in the cost of goods sold, you cannot deduct it again as a business expense.

The following are types of expenses that go into figuring the cost of goods sold.

• The cost of products or raw materials, including freight
• Storage
• Direct labor costs (including contributions to pensions or annuity plans) for workers who produce the products
• Factory overhead

Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs.

This rule does not apply to personal property you acquire for resale if your average annual gross receipts (or those of your predecessor) for the preceding 3 tax years are not more than $10 million.

For additional information, refer to the chapter on Cost of Goods Sold, Publication 334, Tax Guide for Small Businesses and the chapter on Inventories, Publication 538, Accounting Periods and Methods.

□        Capital Expenses

You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called capital expenses. Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize.

• Business start-up cost (See the note below)
• Business assets
• Improvements

Note: You can elect to deduct or amortize certain business start-up costs. Refer to chapters 7 and 8 of Publication 535, Business Expenses.

 □        Personal versus Business Expenses

Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part.

For example, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you can deduct 70% of the interest as a business expense. The remaining 30% is personal interest and is not deductible. Refer to chapter 4 of Publication 535, Business Expenses, for information on deducting interest and the allocation rules.

□        Business Use of Your Home

If you use part of your home for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Refer to Home Office Deduction and Publication 587, Business Use of Your Home, for more information.

□        Business Use of Your Car

If you use your car in your business, you can deduct car expenses. If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. Refer to Publication 463, Travel, Entertainment, Gift, and Car Expenses. For a list of current and prior year mileage rates see the Standard Mileage Rates.

Other Types of Business Expenses

• Employees’ Pay – You can generally deduct the pay you give your employees for the services they perform for your business.
• Retirement Plans – Retirement plans are savings plans that offer you tax advantages to set aside money for your own, and your employees’ retirement.
• Rent Expense – Rent is any amount you pay for the use of property you do not own. In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. If you have or will receive equity in or title to the property, the rent is not deductible.
• Interest – Business interest expense is an amount charged for the use of money you borrowed for business activities.
• Taxes – You can deduct various federal, state, local, and foreign taxes directly attributable to your trade or business as business expenses.
• Insurance – Generally, you can deduct the ordinary and necessary cost of insurance as a business expense, if it is for your trade, business, or profession.

This list is not all inclusive of the types of business expenses that you can deduct. For additional information, refer to Publication 535, Business Expenses.

References/Related Topics

• Virtual Small Business Tax Workshop, Lesson 2 – How to set up and run your business so paying taxes isn’t a hassle
• Virtual Small Business Tax Workshop, Lesson 4 – What you need to know when you run your business out of your home
• Standard Mileage Rates, A summary of the optional standard mileage rates to be used in computing the deductible costs of operating an automobile for business, charitable, medical, or moving expense purposes.

Page Last Reviewed or Updated: May 03, 2010

Source:  http://www.irs.gov/businesses/small/article/0,,id=109807,00.html