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Sometimes Shelters Can Be Scams

By Jane Bryant Quinn
Sunday, June 30 1996; Page H02

A favorite tax scam today -- promoted by get-rich gurus in high-pressure seminars and on cable TV -- is starting a sideline business. You keep your regular job but start a little business at home.

Once you've printed those magic business cards, your personal life supposedly becomes tax-deductible. You can write off your car, your vacations, your kids and lots of other bills.

But that's just a hustler's dream. These promoters are selling a phony story, to get you to buy their how-to books and tapes or invest in their dubious small business opportunities. Often, you'll wind up with a business loss and a nasty tax audit, too.

The Internal Revenue Service has no problem with legitimate part-time businesses. When you offer a product or service in a businesslike way, your documented business expenses become tax-deductible.

These include such direct expenses as a business phone, business magazine subscriptions, advertising, office supplies and equipment, the wholesale cost of any products you resell, employee wages (including wages paid to your spouse and kids), office furniture, entertainment, business travel and a business car.

You can write off these costs on your tax return, even if your business makes no money. Presto, you have a tax shelter. These costs reduce your taxable income from your regular job. If your business earns enough, you can write off your home office expenses, too -- for example, the "office" portion of your home heating and electric bills.

The best home businesses grow out of a personal interest or area of expertise. You can also buy prepackaged businesses, complete with advice on how to get started. I'd rate them iffy. The promoters often overstate your chance of success.

Success is essential, if you hope to continue your tax deductions. The enterprise normally has to turn a profit in three of the first five years. If it doesn't and you're audited, the IRS will probably rule that it's not a real business, it's just a hobby (although you might be given a grace period if you're seriously trying to make a go of it).

With a hobby-business, you can still deduct expenses up to the amount of your net business income. But you're not allowed to tax-deduct additional expenses, so your tax shelter goes bye-bye. What's more, all prior expenses in excess of business income will be disallowed. You'll owe back taxes, interest and penalties.

Your only way out of this expense is to close the business, said Dan Gleason, president of My Tax Man in Ocala, Fla. That way, you keep most of your prior deductions. However, you do have to repay any write-offs you took for accelerated depreciation. Gleason recommends that start-up businesses not take accelerated depreciation, just in case.

Those vaunted home-based deductions also might get you into trouble.

For example, take your "business auto," which probably is your personal car. You can deduct 31 cents a mile for business use, plus parking costs, tolls and a portion of the car-loan interest. But you have to document the business miles driven. That means a driver's diary, showing the date, purpose and mileage of each business trip.

And take the claim that you can deduct your vacations. No way. Only business trips are tax-deductible.

You can combine a business trip with a vacation. But to deduct the cost of travel, you have to document that the trip's primary purpose was business. Visiting a supplier or having a job interview is not enough. One day of business might let you deduct one day of hotel bills, meals and some taxi fares, but that's all.

To tax-deduct a spouse traveling with you, he or she has to be an employee of the business and have a legitimate business reason for being there.

And take the practice of paying your kids tax-deductible salaries instead of an allowance. First, the kids have to do real, documented work. Second, you have to treat them like employees, preparing W-4 forms (for withholding tax), filing quarterly 941 forms (showing wages paid to family employees) and issuing W-2 forms at the end of the year. Without this paper trail, their "wage" deduction may be disallowed.

Many people who start sideline businesses -- especially those who write off personal expenses -- suspect that their deductions are too good to be true, Gleason says. They're playing audit lottery, but may pay for their fun by getting into a wrestling match with the IRS.

Next: Legitimate home-business deductions

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