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There
are four important considerations in the treatment of your business's
expenditures:
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Match
all allowable ordinary and necessary expenses of your business for each
tax year against taxable income. Ordinary and necessary business
deductions include all the expenses that are required to operate your
business. These deductions aren't particularly difficult to understand,
nor do they require any special knowledge in order to deduct properly.
However, some do require the application of specific tax strategies to
maximize their tax advantage. Ordinary and necessary expenses include
all your business-related expenditures, such as: accounting, legal and
bank services, office expenses, your car, equipment, travel,
entertainment, retirement, wages and salaries, employee benefits,
marketing, insurance and payroll taxes, to name just a few.
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Deduct
ordinary and necessary business expenditures in two ways. First,
deduct items with a useful life of less than the current tax year by
expensing these items—deducting them all in the current tax year.
Second, capitalize on the following two sub-categories by deducting them
over a specific period of time in the future (greater than one year):
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Startup
expenditures are incurred prior to your business actually beginning
its operations; startup ends when your business actively begins to
offer products and services to potential customers. These startup
expenditures are totaled and deducted over a 60-month time period,
beginning when your business actually makes its products/services
available for purchase.
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Expenditures
for items with a useful life greater than the current tax
year—such as equipment, furniture, fixtures and vehicles—are all
deducted over 60 months or less. Any commercial real estate property
used in your business will be deducted as 39-year property.
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You
must allocate expenditures between personal and business use. An
expenditure does not have to be either entirely deductible or
nondeductible. The personal portion is not tax-deductible; however, the
business part is fully tax-deductible as a business expense. This
allocation process is referred to as prorating expenditures between
personal and business use.
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Avoid
the IRS's "hobby rule." You are presumed by the IRS to be
in business with the intent to make a profit. If you do not show a
profit in three out of five years, you may be required to demonstrate
and defend the fact that you are operating with the genuine intent of
making a profit. It is generally rather easy to prove this by showing
the capability your business has to provide products and services to
potential customers and making significant marketing efforts. However,
you are better off if you never have to prove anything to the IRS. For
that reason alone, you should manage your activity with the idea of
creating a profit. Furthermore, if your business is not profitable, why
are you still in that business, anyway?
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