Top Ten Tax Tips
The bottom line is simple: Each year, many gift shop retailers miss all kinds of deductions simply because they are not aware of them—or because they neglect to keep the records necessary to back them up. While the ever-vigilant Internal Revenue Service is quick to jump on anyone attempting to claim more than they are legitimately entitled to, rarely will the IRS point out missed or overlooked deductions.
Under our tax laws, a transaction must generally be completed prior to the end of the tax year. That means Dec. 31 for most gift shops. Surprisingly, it is not too late to benefit from 2006 transactions on the current tax returns. While little can be done to structure already-completed transactions to reap the most tax benefits, ensuring that legitimate deductions are not neglected is vital all year-round.
In the beginning
This is a good time to think about the form in which your gift shop is operated. The IRS’s “check-the-box” tax rules permit many of us to choose, on the tax return itself, to be treated as a corporation or a partnership. The decision, however, is far more complex—and long-lasting—than that. Since different such “operating forms” come with different tax benefits and structures, now might be a good time to discuss the operating form of your business with a tax professional. In fact, it is a good idea to run all tax-related strategies, deductions and transactions by the professionals your operation should be relying on. Professionals are not just for taxes, they are also for legal, liability and other concerns.
1 Deduction for operating expenses
The operating expenses of a gift shop include all ordinary and necessary expenditures—the bread-and-butter costs that every gift shop incurs for things such as rent, supplies and salaries. A gift shop retailer—whether doing business as a corporation, an individual or a partnership—is permitted to deduct (from gross income) all of the ordinary and necessary expenses of carrying on a trade or a business that are paid for or incurred in the tax year. However, no tax deduction is permitted for any expenditure that is a capital expense. An expense that adds to the value or the useful life of property is considered a capital expense.
2 Deduction for depreciation
Another deduction to consider is the depreciation deduction, which is usually defined as a reasonable allowance for the exhaustion of property used in a trade, a business or a property held for the production of income. In other words, depreciation is a reasonable allowance for the natural wear and tear of all business assets. For example, if the Point of Sale system you use is no longer new, you may deduct a portion of its original cost as the equipment grows older and less productive. Instead of capitalizing assets or deducting their costs over a number of years, some small businesses can write off the full cost of some assets in the year when they were purchased. Section 179 of the tax code permits an immediate deduction of up to $108,000 for new equipment or other assets (subject to a phase-out if you placed more than $430,000 of equipment in service in any one year). That means if you bought and began utilizing more than $430,000 worth of assets in one year, the Section 179 write-off for the year would be reduced, dollar-for-dollar, for all purchases in excess of $430,000, and you would have to phase those expenses out over a few years. The cost of the asset is based on its “basis” or “book value.” The “cost basis” of an asset is the one entered in the books for tax purposes—i.e. the actual cost plus freight charges or minus depreciation costs. Remember that capitalized impovements to an existing asset are not a new equipment acquisition under Section 179.
Unfortunately, some assets—especially real estate, inventory bought for resale and property purchased from a close relative—do not qualify for this Section 179 write-off.
3 Deduction for repairs
Expenses that keep gift shop property in “ordinarily efficient” operating condition, and do not add to its value or appreciably prolong its useful life, are generally deductible as repairs. For example, replacing one shelf of a shelving system might be considered a necessary function to keep the store “ordinarily efficient.” But replacing the entire shelving system might not be—because it might be argued that such an action considerably prolonged the system’s useful life.
Inventories are necessary to calculate profits, but not required by our tax laws—unless the gift shop operation’s gross receipts exceed $1 million, in which case the gift shops must also use the accrual method of accounting. In this method, income is taxed when invoices for accounts receivable are sent out and expenses become tax-deductible when an order is placed, regardless of when it is paid for.
4 Deduction for business taxes
Small-business owners often ignore the taxes paid by their businesses, or on purchases made to operate their businesses. Sales tax on items purchased for a business are deductible as part of the cost of the items; it is not deducted separately. If you—or your business—pay employment taxes, the employer’s share of these taxes is deductible as a business expense. Self-employment tax is paid by individuals, not their businesses, and is not a business expense.
5 Deduction for real estate taxes
Real estate tax on property used for business is deductible, along with any special local assessments for repairs or maintenance. If the assessment is for an improvement—for example, to build a sidewalk—it is not immediately deductible; instead it is deducted over a period of years. Remember, you do not have to be the owner of property to deduct taxes paid. Tenants required to pay property taxes for their leased property are entitled to the deduction, not the landlord.
6 Deduction for energy-related costs
Commercial building owners benefit from tax law provisions that reward them for buying equipment or systems to make their property more energy efficient. After Dec. 31, 2005, and before Jan. 1, 2008, every gift shop may claim a deduction for costs associated with energy-efficient commercial building property. The shop owner does not have to own the building to qualify for the deduction, but exceptions to this law are complex. Consult your tax professional to see if you qualify for this deduction. Energy-efficient commercial building property involves property, systems or equipment installed as part of interior lighting systems; heating, cooling, ventilation and hot water systems; or the building’s envelope (the outer walls, roof, etc.).
7 Deduction for legal & professional fees
Fees paid to lawyers, tax professionals or consultants are generally deducted for the year in which they were incurred. If, however, the work clearly relates to future years, the expenses must be deducted over the life of the benefit received from the lawyer or other professional.
8 Deduction for operating expenses
The cost of advertising your goods and services is deductible as a current expense. Promotional costs that create business goodwill—sponsoring a Little League team, for example—are also deductible, as long as there is a clear connection between the sponsorship and the gift shop business. Naming the team after the business or listing your operation in the program is evidence of the promotional effort.
9 Deduction for miscellaneous health-care costs
When it comes to tax deductions, gift shop owners should not overlook themselves. Uncle Sam wants you to enjoy the fruits of your labor—after taxes. As business owners, gift shop retailers have an advantage that most others do not when it comes to health care: They can deduct many of their health insurance costs. In addition, gift shop operators can deduct a variety of uninsured medical expenses, including the costs of nonprescription medications, acupuncture and eyeglasses.
10 Deduction for entertainment
Frequently, important business meetings, customer contacts and marketing efforts occur at restaurants, golf courses or sporting events. Gift shop operators can deduct half the cost of their business-related entertainment. Remember, however, that taxpayers continue to abuse this deduction, forcing the IRS to impose strict rules limiting the types and amount of entertainment costs that are tax-deductible. Gift shop retailers attend many tradeshows throughout the year. Generally, travel expenses incurred are also deductible.
Retirement accounts are also worth mentioning here. When it comes to saving for retirement, the government allows small businesses to set up retirement accounts specifically designed for small-business owners. These retirement accounts may not favor the business owner or a highly compensated employee at the expense of other lower-wage employees, but they can and do provide enormous tax benefits intended to maximize the amount of money that can be put away in tax-deferred accounts during working years. In the area of fringe benefits, retirement plans and the like, the majority of shareholder/owners, partners and principals are considered employees, and are entitled to reap all rewards offered by the business. Naturally, these benefit programs cannot discriminate in favor of the owner/shareholder.
Taxes are on everyone’s mind this time of year. What better time to guarantee that all appropriate tax deductions have been claimed. It is also a good time to simultaneously incorporate tax strategies into your planning and budgeting for 2007.
Editor’s note: The tax tips outlined in this article are meant as guidance only. Readers are advised to consult tax professionals before claiming any of the tax deductions listed above.