An unexpected letter from the Internal Revenue Service can make your stomach drop, but you can take steps to reduce your audit risk.

Taxpayers overall face a low audit risk: The IRS audited 1.1% of all individual tax returns filed in 2010, or 1.6 million returns of 141 million filed.

The vast majority of those audits—1.2 million—were done by mail. Just 392,000 involved an in-person meeting with the IRS. That’s not necessarily good news. Taxpayers often are confused by IRS correspondence, and with such audits they don’t have the benefit of working with one single agent, the National Taxpayer Advocate says.

But the risk of an audit skyrockets for some. Fully 12.5% of taxpayers whose income topped $1 million faced an audit. And self-employed people who filed a Schedule C with gross receipts of $100,000 or more faced an audit rate of about 4%—four times higher than average taxpayers. Here are seven red flags:

Schedule C

Sole proprietors filing a Schedule C can reduce their audit risk by sticking to the facts—or at least making sure their expenses and income are not dramatically different from similar businesses.

For example, one Chicago-based hot-dog-stand owner said his cost of goods sold was 50% of gross receipts, says Robert McKenzie, a partner in the law firm Arnstein Lehr. “I know Chicago hot dogs are great, but he had a high cost.”

The IRS found the hot-dog salesman was reporting his expenses but only part of his revenue. He faced “a lot of tax and penalty,” Mr. McKenzie says.

Check out BizStats.com for an idea of whether your numbers are out of line; Mr. McKenzie says the IRS tells its agents to review that site for average business costs.

Over-the-Top Deductions

Taxpayers who claim large deductions attract attention. “Anything that is significantly above what persons in your income bracket might deduct is likely to be looked at,” says Mr. McKenzie.

“The mantra I preach to my clients is keep good records,” says Audrey L. Griffin, an enrolled agent in Centerville, Ga. “You’re going to get the best possible, honest, legal result and you have nothing to fear.”

Business or Hobby?

The IRS may decide your business is a hobby—especially if you have other income sources. For example, Mr. McKenzie says, the IRS disagreed with an executive who, in addition to his annual salary of $500,000, deducted expenses for his yacht, claiming it was a business charter operation.

In another case, a young man with annual trust-fund income of $300,000 decided to become a race-car driver. He wrote off his costs, including the car, maintenance and the like.

In both cases, the taxpayers settled with the IRS for a partial write-off, Mr. McKenzie says.

Rental Losses

If you show income from your job or business and claim rental-property losses, be wary. IRS rules limit deducting those losses in the current year, unless you prove you’re actively involved in managing the property.

“It’s a real hot item right now: Audit people who make significant income from their jobs and also claim rental losses,” Mr. McKenzie says.

In one case, the wife of a real-estate attorney—a stay-at-home mom with three young kids—managed the family’s rental properties, but the IRS said the couple couldn’t deduct rental losses in the current year. On appeal they won their case, Mr. McKenzie says.

“We were able to prove yes, he couldn’t have devoted 50% of his time [to the rentals] and made $600,000 a year, but she could,” he says.

Business Use of a Car

Ms. Griffin’s clients often insist that 100% of their driving is related to business and thus their costs are 100% deductible, but when she digs deeper she finds they often use that same car for non-business purposes.

“Then it’s not 100%, which is the reason the IRS requires you to keep mileage records,” she says.

Home-Office Deduction

You may be able to claim a deduction for expenses related to your home office, including home-insurance and utilities costs, but be prepared for the IRS’s attention.

“I would not discourage a client from taking that deduction if they qualify. I just try very hard to make sure they know the requirements and keep good records,” Ms. Griffin says.

But is it worth it? You would claim a deduction for a percentage of the housing expense related to the square feet of office space divided by the home’s total square footage. “It may be a very small percentage and it may not be worth raising this red flag,” Ms. Griffin says.

Earned-Income Tax Credit

Among people who claimed the EITC—a refundable credit worth up to $5,751 in 2011 for moderate-income taxpayers—2.2% of returns filed in 2010 were audited.

There’s a “high level of noncompliance,” Mr. McKenzie says, often because fraudsters exploit this benefit to line their own pockets. For instance, scammers will provide an extra Social Security number so taxpayers can claim an extra dependent—and increase their credit.

It’s a valid tax credit—just mind the scams and stick to the truth.

By ANDREA COOMBES

Article source: Wall Street Journal

 

In 2005, when 15-year-old Peter Crabtree of Poulsbo, Wash., turned his high school culinary-arts training into an upscale chocolate-making business, CBC Chocolates, he saw some early success but not much.

So he started considering what else he could do to make his business more appealing. He wondered what other products he could source as a young, bootstrapping small-business owner. What he found and the new business idea he put together would make him a local celebrity.

Raised on a farm, Crabtree had easy access to natural beef. Living in the Northwest, he was also near other great local food growers and boutique wineries. After some research into what was available, he decided to pivot his business and add some more items besides chocolate.

A year ago, the business morphed into ChocMo, an upscale chocolate bistro featuring beer, wine, paninis, cheese, that naturally raised beef from his family’s farm and a line of decadent chocolate desserts.

Soon, ChocMo had become the new, hip hangout in town. Where else could you get gourmet chocolates and a great local glass of wine in the same sitting? Nowhere. And we all know how well wine and chocolate go together.

Now, Crabtree recently told his local business journal, “I feel we’ve just hit critical mass.”

Often, the first idea you get for a business is really just the germ of an idea. It needs more work. It needs to be developed and different angles need to be tried before you hit on the one customers love.

The difference between being a successful entrepreneur and just another flameout is often the willingness to keep evolving your idea. Respond to customer feedback frequently — even after you hit the sweet spot where your passion and the marketplace meet.

Have you tweaked or even switched your business idea? Leave a comment and share how you changed it.

Article source: Entrepreneur.com

 

Cash is king, especially during difficult economic times. More and more business owners are thinking out of the box when it comes to trying to keep morale up in the workplace.

Promotions are an obvious way to try to boost morale, especially among key employees who generally are happy to have increased duties and status.

But how can you afford to do so when there is no extra money to provide raises? What if your revenues are way down, yet you cannot afford to lose your key people to the competition?

One of the ways some business owners are tackling this dilemma is to promote key employees, but not give them raises connected to their promotions.

There is certainly nothing illegal or inappropriate about this practice. It seems to be growing during these uncertain economic times.

Only 48% of small-business owners said they increased employee compensation during the previous 12 months, in a recent online poll of 450 members of the National Small Business Association. That’s the highest it’s been since August 2008, when the figure was 51%.

If this is the first time you have implemented this practice of so-called “title-only” promotions, there are a few issues to consider.

First, it makes sense review the demographics of the prior employees in recent years who were promoted with raises, then compare them to the employees you’re considering promoting without a raise.

Suppose, for instance, that two years ago a white male employee was elevated from being an hourly worker to a salaried manager and received a raise. Now, this year an African-American female employee is going to be similarly promoted with no raise. You better be prepared to explain the business rationale for this decision.

If the business environment has gotten worse, that perhaps can explain the different treatment. But if your business is simply stagnant with no growth, a creative plaintiff’s lawyer might make a case for discrimination. That case could be made based on the fact that since nothing has changed, the African-American female employee should be treated the same as white male employees was a few years back.

Of course, there may be legitimate non-discriminatory business reasons for the different treatment. But the point is that you should be prepared to articulate those reasons to avoid being unnecessarily exposed to these arguments.

What’s more, it is important for you to communicate why no raises are forthcoming even though your employees are promoted—whether that’s because your industry overall is down, or whether because there are specific issues in your company that have caused a slowdown, such as losing a key contract or customer, or because a big client hasn’t paid its bills.

This will not only make the employees feel as if they are truly a part of your team but, importantly, if and when the employees are asked about the salary freeze they will be in a position to tell anyone asking—including a plaintiff’s lawyer– the legitimate reasons why.

That’s certainly better than the employee being in the dark and perhaps suspicious of the reasons, and then voicing those suspicions to inquiring minds.

You should also put a time frame on the freeze, creating a clear timeline for when you will reevaluate your position. Whether in three months, six months or even a year. Your employee should know where he or she stands relative to potentially being rewarded for increased responsibilities.

The last thing you want is to have an employee who was promoted to start feeling as if though they have been taken advantage of, because morale then goes down

Finally, remember that you also need to be wary of overtime considerations under the Fair Labor Standards Act when promoting employees and not providing raises.

Often times, when a business owner promotes an hourly employee into a “management” position and converts the employee’s pay structure hourly to salary, he or she presumes that the employee is not entitled to overtime compensation. This is not necessarily so.

Write to smalltalk@wsj.com

Article source: Wall Street Journal

 

Smartphones are giving new meaning to the term comparison shopping.

Whether they’re seeking lower prices or better terms on an item they see on a store shelf, consumers are quickly learning that their smartphone can be used for more industrious tasks than playing Words With Friends or snapping and posting photos on Facebook.

Last year, more than half of U.S. smartphone users performed retail research while inside a brick-and-mortar store, with nearly one in eight using their phone to compare prices in real time, according to comScore’s “2012 Mobile Future in Focus” report. Tack on the fact that 42 percent of mobile cell users in the U.S. own a smartphone, as do 44 percent of European mobile-phone users, and that little stat may amount to a big-business loss for your bricks-and-mortar store.

As smartphone adoption becomes more widespread, consumers are presented with mobile buying power once restricted to the home or work computer. Freed from the shackles of a desktop, shoppers can now stroll right into your operation, pull out their smartphone and start some serious comparative shopping. They can scan your merchandise, read reviews, ask friends for recommendations and share with you what they’ve found. And if they’re not satisfied with your response, they locate a business that has better prices or service.

What this means for small-business owners is you and your staff have to get in front of smartphone-wielding consumers, ask a shopper if they’re comparison shopping and offer a solution if it makes sense to do so. Conversely, rewarding shoppers who learn about your products or services through a mobile device may earn you a customer and their recommendation for life.

Among other findings in the comScore report:

• During December of last year, 64.2 million U.S. smartphone users accessed social networking sites or blogs on their mobile devices at least once, with more than half reading posts from brands, organizations and event organizers.
• Also in December of 2011, 20 percent of smartphone owners in the U.S. scanned a QR code.
• Men and women display differing patterns of shopping-related behavior when it comes to smartphones. Women tend to use their smartphones to make shopping a more social experience as they take product pictures (24 percent), send them to family and friends (20 percent) and call or text people about a specific product (22 percent). Men are more likely to use their smartphone to scan a product barcode (20 percent), comparison shop (14 percent) and research product features (11 percent).

How has smartphone adoption among your customers helped or hurt your business? Leave a comment and let us know.

Article source: Entrepreneur.com

 

Business Model Generation: A Handbook for Visionaries, Game Changers, and Challengers Alexander Osterwalder and Yves Pigneur (Wiley; $34.95)
This manic collection of typography, photographs, sketches and graphs is actually a crowdsourced collection of expert advice designed to help you disrupt your industry. You’ll learn how to think about your business in new ways, ask the right questions to find new opportunities and develop a plan for your company’s evolution.
Dig Your Well Before You’re Thirsty: The Only Networking Book You’ll Ever Need
Harvey Mackay (Currency Books; $16.95)
Mackay teaches how to network strategically without being disingenuous. He delivers a solid mix of advice and action to help build an effective network that returns on your time investment. The tone gets a little “rah-rah” at times, but this is a master networking class that goes far beyond business cards and LinkedIn invitations. And the list of 16 contacts everyone should know is just plain smart.

The E-Myth Revisited: Why Most Small Businesses Don’t Work and What to Do About It
Michael Gerber (HarperCollins; $18.99)
If you’ve already read it, read it again. This seminal book on entrepreneurship teaches business owners how to get out of the day-to-day rut and resume the role of visionary. Its straightforward, no-nonsense style helps you spot ways to make your business more effective and efficient, freeing you to look for the Next Big Thing–and still have a life of your own. Gerber reminds you how to be in charge, which is a lesson even leaders need now and then.
The Wall Street MBA: Your Personal Crash Course in Corporate Finance
Reuben Advani (McGraw-Hill; $18.95)
No MBA? No problem. The Wall Street MBA takes the role of mentor, coaching on the basics of corporate accounting and financial statements. While it could have easily veered into the mind-numbingly dry, the book has an engaging tone and is full of anecdotes that make it an accessible read on finance basics for growing companies, including accounting standards, operational and capital cost analysis and valuation strengths and weaknesses.
The World Is Flat 3.0: A Brief History of the Twenty-First Century
Thomas Friedman (Macmillan; $16)
The Pulitzer Prize winner and former New York Times foreign affairs columnist has updated his bestselling The World Is Flat, sketching out the fast-paced changes of the 21st century in a global economy. From values and technology to economics and shifting socioeconomic profiles, Friedman chronicles the changing world and the factors contributing to these shifts. Even local businesses need to understand the opportunities and threats of a global economy, and this book is an excellent primer.
The Godfather
Mario Puzo (Signet; $9.99)
Leaving aside the murder and mayhem, this blockbuster 1969 novel holds its share of leadership profiles. Issues like managing multiple businesses, dealing with problem employees and fighting off cutthroat competitors (often, quite literally) will feel familiar to every business leader–even if Victor and Michael aren’t exactly perfect role models.

This article was originally published in the March 2012 print edition of Entrepreneur with the headline: Words of Wisdom: Recommended Reading.

Article source: Entrepreneur.com

 

Many start-up founders and owners of existing small businesses wonder what their companies could possibly gain from yet another new form of social media. Finding adequate time to properly manage business profiles that already exist on Facebook, Twitter and LinkedIn is enough of a challenge.

But the newcomer Pinterest could offer advantages for some small businesses, particularly those specializing in e-commerce.

The social network lets entrepreneurs create online scrapbooks featuring photos of their newest or most popular products. Importantly, it also provides them a platform to write compelling descriptions of those products, and to embed links that direct consumers to their websites or to order forms.

A product could potentially go viral because of the way the social network allows its users to “follow” other users, including businesses. If someone follows say, Etsy.com, the online crafts marketplace, his or her own Pinterest profile will then display all of the images on Etsy’s Pinterest profile.

Keep in mind: Etsy’s brand is particularly suitable for Pinterest, because both sites are popular with women and creative types. Since joining the social network in October 2010, Esty’s main profile already has accumulated more than 51,000 followers.

To start, try to spend a few days or weeks using Pinterest as consumer to get a sense of how it works before diving into it for your business. Also, study what other businesses already on Pinterest have done.

Some tips:

Create categories.

Take a cue from Warby Parker Inc. of New York, with its Pinterest profile showcasing the brand’s eyewear, combined with other images that are intended to say something about its culture and mission. Notice how its profile is separated into categories, or “pin boards,” with themes such as “Fresh New Frames” and “Sunglasses are a Must.”

Use images with personality.

“The images that get shared the most are funny, inspiring or emotional,” says Jason Keath, a social-media analyst in New York. You don’t need to invest in professional photography. However, the images you post to Pinterest should be visually striking. “People share images that make them look good,” Mr. Keath says.

Be selective.

Highlight only a few of your most popular or newest items so your profile doesn’t look like an advertisement.

If you own a service-based business, use images that show what your brand is about. Balance Yoga Studio LLC of Woodinville, Wash., for instance, shows photos of magazines and books on healthy living, plus graphics with inspirational quotes like “Keep Calm and Carry Om.”

“It’s just creating more of a yoga community online for us,” says owner Michelle Michael, whose 20-employee company launched in October and created its Pinterest profile last month.

Write breezy descriptions.

The images you pin to your profile from a Web page will automatically include an embedded link to that page—but not a caption. Use this space to give users updates on what’s new with your business, as well as to describe product.

“Happy Valentine’s Day! We added Coral to our colors! This is the Light Duty Fish Tail Bracelet,” wrote, Survival Straps, a Jacksonville, Fla., maker of utility-cord bracelets that recently started using Pinterest, in a pin earlier this month.

Use the widgets.

Add a “Pin It” or “Follow” button to your company website by going to Pinterest’s “Goodies” page and following the instructions provided. You can also download the Pinterest logo to your site from the same page.

Add many links.

By clicking “Settings” and filling in the prompts, you can include links to your company website, as well as your Twitter, Facebook and LinkedIn profiles from your Pinterest profile. Then, add links to back to your Pinterest profile from each of those pages.

By creating these trails for consumers, you’ll help lead them to your site. “It’s like a breadcrumb strategy,” says Larry Chiagouris, a professor of marketing at Pace University’s Lubin School of Business.

Write to Sarah E. Needleman at sarah.needleman@wsj.com

Article source: Wall Street Journal

 

Lewis S. Jacobus took over his parents’ ailing home-decor business two years ago intent on turning it around by rebranding it as a retailer of game-room products, such as pool tables and dart boards. But he had virtually no money to spend on advertising the shop’s new image.

So Mr. Jacobus began searching Facebook for nearby retailers to see if any would be willing to promote his store for free in exchange for him doing the same. The strategy quickly paid off.

Mr. Jacobus connected with the owner of a Christmas-tree business about 25 miles away. He says they agreed to place sample products and advertising materials in each other’s shops, including coupons specifically drawn up for the partnership. Over the next few weeks, he says both businesses generated sales as a direct result.

“Working together is a way to get your name out there,” says Mr. Jacobus, 27 years old, who became an entrepreneur to save his parents’ 30-year-old New Hampton, N.Y., business, now called Hudson Valley Game Rooms, after his father developed cancer.

One way to grow your small business on a limited marketing budget is to team up with other small businesses that target the same types of customers—but aren’t your direct competitors—and promote each other’s products or services.

The tactic typically requires a lot of networking and relationship-building, which can take time and may not always pan out. But entrepreneurs who have engaged in the practice say it can work and that it beats spending hundreds or thousands of dollars on traditional marketing efforts, like TV, newspaper or radio ads.

“This is the old barter system,” says Bruce I. Newman, a marketing professor at DePaul University in Chicago. “What’s the cost? A phone call.”

Mr. Newman recommends pursuing partnerships with companies that sell complementary goods or services and keeping tabs on your progress to see how effective it is. “Build a database once you start doing this so it can be tracked, measured and monitored over time,” he says.

Sheryl Connelly of Louisville, Ky., has literally gone door to door asking the owners of nearby businesses if they would be interested in doing cross-marketing with her start-up, Marketing Media Management, a provider of social-media services. She also has approached prospective partners through LinkedIn.com and at networking events.

But she says she doesn’t actually mention anything about a possible partnership upfront. Rather, she tries to get to know the entrepreneurs she targets to be sure they’re a good match.

“You’re gathering information,” says Ms. Connelly, who started her business after getting laid off from a sales job in 2009. “You need to be comfortable. It’s about your credibility.”

To date, the 40-year-old entrepreneur says she’s developed six partnerships that entail swapping customer referrals. For example, one partner is the owner of a computer-repair business and their agreement is such that if any of her clients mention having computer trouble, she recommends they call that partner.

Likewise, if any of the partner’s customers indicate that they use social media for marketing, the partner will recommend Ms. Connelly’s firm for support in that area.

“I went from one lead a week to about 10,” says Ms. Connelly. “And they’re solid leads. You’re riding on their credibility, which speaks volumes.”

Of course, not every attempt to strike up a partnership is likely to work out. Mary Tamargo, owner of Nocube, a digital-marketing start-up in Rochester, N.Y., says there were a handful of times when entrepreneurs she hoped to team up with either turned her down or didn’t follow through on their end.

But since becoming her own boss in late 2010, just prior to getting a pink slip from a health-care company, Ms. Tamargo, 36, says she has managed to drum up lasting partnerships with three consultants whose clients are mostly small pharmacies—also her target market.

Partnerships don’t necessarily need to involve exchanging the same kind of support. Entrepreneurs can scratch each other’s backs so to speak by agreeing to assist one another in ways that make the most sense for them.

Sara Marshall of Jersey City, N.J., says she learned of a creative product-display technique from an entrepreneur she met last spring at a farmer’s market. In return, she introduced her peer to a retail store that now carries that woman’s cookies and breads.

Ms. Marshall has been selling her own brand of salsa under the name Saucy Sara’s Salsa since getting laid off from a communications job in 2009. She says the partnership she has works in large part because she and her peer are in the same market and have similar goals.

“Everyone’s having a hard time because of the economy,” says Ms. Marshall, 46. “Everyone wants to succeed.”

Write to Sarah E. Needleman at sarah.needleman@wsj.com

Article source: Wall Street Journal

 

The terms ‘profit’ and ‘loss’ are common parts of the business vernacular, but not many people fully understand their role in a market economy.  This has become even more pronounced after the recent financial crisis, as the government has attempted to perpetuate a system of profits without losses.  The problem implicit within trying to build a market economy without both profits and losses is that it will inevitably lead to one of two extremely undesirable results.

One sentiment that was popular in the middle of the 20th century was the notion that private profits are fundamentally immoral and that all production should be socialized.  This is the fundamental tenant of socialism and communism, and ultimately results in a stifling of risk taking since the rewards for entrepreneurship become non-existent.  In this environment, the resources available for redistribution don’t grow, and the costs of government control place a tremendous burden on national output as access to wealth becomes a function of political connections instead of skill or productivity.

Another sentiment that has been unfolding over the second half of the 20th and early 21st century is the notion of socializing losses from private activities through creditor bailouts.  The textbook term for business sector that enjoys government sponsored monopoly power and implicit (or explicit) guarantees of solvency is the “corporate state.”  In this model, profits are privatized to politically connected businesses and losses are socialized on the backs of taxpayers.  Some people refer to this as “crony capitalism” … however, the term is an oxymoron since capitalism is a system where market conditions are allowed to prevail and political officials are unable to provide special benefits to their “cronies” through the power of government.

The fundamental characteristic that both of these flawed models share is that they distribute wealth based on political influence instead of ideas and productivity.  In both cases, the government wields tremendous power and entrepreneurship is suppressed by either an absence of profits from success or from entrenched competitors with government backing that crush competition.  The danger that is posed by this model is that the “profits” it generates look the same as earnings from legitimate business activities.  However, the former provides nothing of net value to the marketplace, and the latter is the fundamental foundation of every market-based economy.

In a ‘real’ capitalist economy, profits are generated by success in the marketplace and failure results in losses for both equity and debt investors.  The current brand of “crony capitalism” has architected bailout after bailout of creditors who financed excessively risky business operations.  The importance of this comes from the fact that creditors have historically been the primary guardian of prudence in business activities.

Consider that a creditor receives no premium if a business is successful like a stockholder . . . all that they get is their regular interest payment.  Because of this, creditors in a ‘normal’ environment will demand a higher interest rate from risky businesses.  These higher interest rates will temper risk taking by entrepreneurs since the increased financial obligations will reduce their probability of success.

However, if the government guarantees the debtors of a particular company, then they have no reason at all to encourage prudence . . . they are going to get their money back from the government if things go upside down.  This creates perverse incentives where risk taking becomes more and more intense while the cost of borrowing stays low because of a government guarantee.  When big profits roll in, management gets big bonuses.  If a collapse occurs, the government bails out the creditors and the taxpayers get stuck with the bill.

Even in cases where government guarantees have been “successful” for companies that did not require an explicit bailout, they have contributed to insane risk taking that eventually culminated in the financial crisis of 2008.  Furthermore, these ‘successful’ bailouts are fomenting an even larger collapse, since the fundamental incentives have not changed.  Thus, the system of government guarantees results in an ever increasing avalanche of risks that are concealed from the public through clever accounting tricks until they eventually explode into a massive market collapse.

In the end, both profits and losses are necessary for true capitalism.  Unfortunately, true capitalism has not been present in the developed world for nearly 100 years.  In an environment of increasing manipulation and government control, the strategy for success is to gain control of income producing assets that can be financed with fixed-rate debt.  This will allow you to realize financial gains when the day of financial reckoning arrives and the US government falls back on creating inflation by printing money to finance its bailouts and entitlement promises.

 

About 52% of all businesses are run from home. The number of teleworkers is growing annually.

It’s good to know that some tax savings can result from this work arrangement.

A portion of personal expenses for your home can be turned into a business deduction — if you meet certain rules.

To claim a home-office deduction, you must use the space in your residence as a principal place of business, as a place to meet or deal with customers on a regular basis, or as a separate structure used for the business.

You also must do the above regularly and exclusively for business.

If you’re an employee, you must use the space for your employer’s convenience and not for your own preference. Working after hours at home rather than staying late at the office is probably your own choice and not for your employer’s convenience.

Usually, “employer’s convenience” means that the employer does not have space for you on the company’s premises.

But while the home-office deduction rules are written in black and white, there are some uncertainties that could affect your home office deduction. Think of them as gray areas.

One is the meaning of exclusive use. Clearly, the space must be available 24/7 for business and cannot be used by you or your family for personal reasons at any time during the day or night. Thus, if you use a TV room as an office during the day and your family watches TV there in the evening, you fail the exclusive-use test.

But what about walking through a room? The Tax Court has said that even occasional use of space, such as using a bathroom by family or guests, means your business use is not exclusive. However, the court has also said that incidental use of space, such as family members walking through the office to get to another part of the home, is minimal and won’t cause you to fail the exclusive use test.

What’s the difference between occasional and incidental use?

This is a gray area, but it seems that passing through is not equivalent to using the space.

Storage of some personal items in a space claimed as a home office won’t violate the exclusive-use test. The court has allowed a home office deduction for a garage in which some personal items were kept. So, people, no. Things, yes.

A common belief is that claiming a home office deduction is a red flag to the IRS, practically inviting an audit. There is no IRS data to support this belief and, unfortunately, the belief may be responsible for some taxpayers forgoing the deduction needlessly even though they are otherwise eligible for it.

The best course of action is to talk over your personal situation with a tax advisor to make sure you meet the home office deduction rules.

Keep good records of all expenses related to the home office, and take a photo of the space used as a home office. The photo can help in case the IRS questions your return after you’ve stopped using the space for business.

To learn more about the home-office deduction rules, see IRS Publication 587, Business Use of Your Home.

Article source: Wall Street Journal

 

A persistent situation has developed among the current political and economic climate that forebodes of large potential problems in the future.  This situation finds its source in a phenomenon that we refer to as “Evading the Obvious.”  The way this effect manifests itself is a stalwart refusal to recognize and adapt to the economic realities.  This issue is modestly problematic when constrained to people and absolutely catastrophic when employed by the political authorities.

The reason for this is because people are limited in the extent to which they can impact the overall marketplace.  However, political authorities can establish highly destructive rules and regulations that have the ability to cripple an otherwise vibrant economy.  Of the many pitfalls and problems that public officials can find themselves caught up in, there are three main principles that drive the most evasion of obvious economic truths.  These principles are that spending isn’t free, profits and losses are equally important, and that prices communicate knowledge.

Reality #1: Spending Isn’t Free

Against the backdrop of huge deficits in both the US and Euro-Zone, this truism cannot possibly be expressed poignantly enough.  Every time that any person, business, or government spends money, that money must come from somewhere.  In the cases of people or businesses, the spending frequently comes from either savings or credit.  In the case of governments, it can also come from ‘monetary expansion’ or simply printing new money.  In all cases, it is not free.

The world is a place where resources are limited.  These resources are often represented in terms of money, but there is no scheme that can ever be devised to create new resources out of nothing.  When savings are spent, those savings are not available for spending on anything else.  When money is borrowed, it must be paid back … with interest.  When new money is created, it devalues the money already in circulation.  Any time that money is spent, it represents a choice to bear a certain cost in exchange for a certain outcome.

Thus, the fundamental question for people, businesses, and governments is one of whether their money/resources are being spent in the most effective way possible.  It is certainly true that the notion of effectiveness is inherently subjective.  However, it is also true that when people are spending their own money, they do so much more effectively than people spending other people’s money.

When investors borrow to build a new factory, they do so because the rate of return from the factory is expected to exceed the cost of interest on the loan.  When people spend their savings, they do so because they value what they are buying greater than having a certain amount of money available to spend on something else.  When the government borrows or prints money to spend on “stimulus” projects, the net result is to either create or destroy value.  Projects more valuable than the alternative uses create value, and projects less valuable than the alternatives destroy value.

When one considers that political decisions are made by people who must be re-elected at regular intervals, and who are spending other people’s money, it is not difficult to see how large sums of money are spent on value destroying projects that benefit a particular political constituency.  If we seek economic growth, then net spending needs to be concentrated in areas that will generate more value than the (full) cost of the resources.  It is not possible to create affluence through borrowing to spend on value destroying projects.

Reality #2: Profits and Losses are Equally Important

Another key concept that seems to have been lost over the past five years is the importance of losses in a free market.  Profits exist to encourage innovation and risk-taking, but the risk of loss must be present to encourage prudence, and to weed-out under-performing entities so that the capital can be deployed more profitably elsewhere.  Problems emerge when the government seeks to insulate certain businesses from the impact of losses.  When profits are guaranteed, and losses are bailed out, the result is highly inefficient entities that funnel benefits to their insiders.

The reason for this is because in a competitive market, businesses who take excessive risk or have incompetent management will eventually go bankrupt.  In this scenario, the assets of the business will be sold off at a discount to other entities who behaved more responsibly.  The profit and loss system systematically channels resources from under-performing entities to those who are more effective and more prudent.

The problem that many people see in this process is the ‘creative destruction’ aspect of economic growth that pushes some companies out of business while new enterprises emerge and grow.  In response to this churn of business fortunes, many companies seek protection of their business, while people seek projection of their jobs.  Unfortunately, all of this creates a barrier against the systematic re-allocation of resources toward their most effective use.

Reality #3: Prices Communicate Knowledge

The third, and least well understood of the fundamental realities is that prices communicate knowledge.  When prices for a particular product or service are high, it signals to entrepreneurs that there is an opportunity for profit.  This opportunity attracts new competitors, and this competition often places downward pressure on the prices.  Similarly, when prices are pressed down low by weak demand relative to the amount of supply in the market, it is a signal to the marketplace that there are too many entities in competition with one another.

The problem that many government’s run into regarding prices is their attempts to manipulate prices for political reasons.  Almost every politician in the world will complain about the high price of health care.  However, very few ask why health care costs are so expensive.  Much of the reason comes from the fact that most people access health care through insurance plans where they do not personally bear the costs of care.  This means that they have no incentive to economize, and often consume much more care then they would if they were directly responsible for the costs.

This phenomenon bears itself out over and over in nearly every corner of the economy.  Most of the people who are upset about prices fail to realize that the prices are communicating valuable information.  Instead, they accuse the business charging the prices of ‘greed’ when the business is really just a messenger of market realities.  High gasoline prices stem from a relative shortage of petroleum that drives up market prices.  These market prices are created by other people who are competing for the same petroleum.  The reason the prices rise is because exploration of petroleum has not kept pace with demand.  Thus, the problem is not one of rapacious oil companies, but regulations that constrain supply.  Nobody is able to maintain high prices for long when competing against somebody else who is willing to sell for less.

As we have seen, the phenomenon of “evading the obvious” has a distinctive impact on each individual’s personal, professional, and financial life.  The impact of these fallacious misunderstandings escalate as the scope of influence grows.  As each of us go throughout our own lives, we must stay aware of the fundamental realities so that we can learn to recognize opportunities and take intelligent action.  It is only through embracing the obvious and understanding the reality that we will be able to create a life of happiness and fulfillment for ourselves and the people we care about.