The Internal Revenue Service Website is: www.irs.gov

You may deduct net losses from a business carried on for profit (for which you intend to make a profit). You may not generally deduct a loss from a hobby.

According to the IRS, there are several factors to consider when determining if you are carrying on an activity for profit:

• You carry on the activity in a business-like manner.
• The time and effort you put into the activity indicate you intend to make it profitable.
• You depend on income from the activity for your livelihood.
• Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business.)
• You change your methods of operation in an attempt to improve your profitability.
• You, or your advisors, have the knowledge needed to carry on the activity as a successful business.
• You were successful in making a profit in similar activities in the past.
• The activity makes a profit in some years (and the amount of profit it makes.)
• You can expect to make a future profit from the appreciation of the assets used in the activity.

Sole Proprietorship

• Un-incorporated
• One owner
• No liability protection for personal assets
• Files on Schedule C -attached to the personal tax return
• Income generally subject to self-employment tax

• Two or more owners
• Generally, no liability protection for personal assets
• Files Form 1065
• Partnership pays no income tax. Income flows through to the partners
• Income generally subject to self-employment tax

• No limit to the number of owners
• Generally, liability limited to company assets
• Files Form 1120
• Corporation pays income tax on net profit at corporate rates
• Owners paid through wages or dividends only

• One to seventy-five owners, no corporate owners
• Generally, liability limited to company assets
• Files form 1120S
• S-Corporation pays no income tax, income flows through to owners
• After payment of "reasonable wages," distributions not subject to self-employment tax

• No limit on owners
• Generally, liability limited to company assets
• Unless otherwise elected, one owner files as a sole proprietor, two or more owners files as a partnership
• May elect to be taxed as a corporation or S-corporation
• Income tax, self-employmenttax dependent on form elected

When you are self-employed (filing Schedule C), what do you pay taxes on?

Gross Income
-Deductible Expenses
--------------------
Net Taxable Profit

What taxes do you pay on the Net Taxable Profit?

• Income Tax- The net taxable profit from your business carries to line 12 on Form 1040 and is added to any other income to arrive at your adjusted gross income.
• Self-Employment Tax- (Medicare and Social Security)- You pay 15.3% self-employment tax on 92.35% of your net profit
• When you are employed by someone else, you pay 6.2% social security tax and 1.45% Medicare on your wages, and your employer must match these amounts. When you are self-employed, you must pay the entire amount of 12.4% social security tax and 2.9% Medicare tax.
• Social security tax is capped at wages of $94,200 for 2006, and the Medicare tax has no cap.
  Note: 1\2 of the self-employment tax is the deducted on line 29 of form 1040 to arrive at adjusted gross income.

Expenses that are necessary and reasonable for the conduct of your business are generally deductible (some subject to certain limitations and rules). These include, but are not limited to:

• Cost of Goods Sold
• Advertising
• Auto Expenses
• Commissions and Fees
• Depreciation
• Insurance
• Interest on Business Loans
• Legal & Professional Services
• Office Expenses
• Postage & Freight
• Printing & Copying
• Rent or Lease
• Supplies
• Taxes & Licenses
• Travel
• Meals & Entertainment
• Telephone
• Samples
• Gifts

If you are reselling products, you usually maintain an inventory. You may only deduct the cost of the items you sold during the year, not the total you paid for all the items.

The deductible cost for the first year you are in business is computed as follows:

Purchases
- Value of Items Used Personally
- Value of Ending Inventory
--------------------------------
Cost of Goods Sold

For subsequent years, the computation is:

Value of Beginning Inventory
+ Purchases
- Value of Items Used Personally
- Value of Ending Inventory
----------------------------------
Cost of Goods Sold

There are two alternatives to deducting the business use of your automobile: the mileage method, and the actual expense method. For either method, you must document your business use of your automobile.

Under the mileage method, you simply deduct a standard mileage rate for each business miles driven. This rate is changed often, usually annually, by the IRS. The standard mileage rate for 2005 is 40.5 cents per mile. Under the actual expense method, you may deduct the portion of actual expenses attributable to your automobile proportionate to your business use. For example, if you used your car 60% of the time for business, you may deduct 60% of the expenses. Expenses include depreciation (subject to limitations), licenses, gas, oil, lease payments (subject to limitations), insurance, registration fees, repairs, and tires. A portion of the interest paid on a car loan may also be deductible.

You can deduct ordinary and necessary expenses when you are traveling away from your 'tax home' for business purposes. Travel expenses include airfare, bus, train, taxi, lodging, and tips.

Whether or not your Travel Expense is deductible depends on many factors, including whether the trip is entirely business, or both business and personal. There are also specific rules for travel outside of the United States and luxury water travel.

Meals and entertainment while traveling for business may also be partially deductible, but subject to certain limitations.

You can deduct ordinary and necessary expenses to entertain a client, customer, or employee if the expenses meet the directly-related test or the associated test. Generally, only 50% of qualified meal and entertainment expenses may be deducted.

In order to meet the directly-related test, you must show that:

1. The main purpose of the combined business and entertainment was the active conduct of business.
2. You did engage in business with the person during the entertainment period.
3. You had more than a general expectation of getting income or some other specific business benefit at some future time.

In order to meet the associated test, you must show that the entertainment is:

1. Associated with the active conduct of your trade or business.
2. Directly before or after a substantial business discussion.

If you have gifts in the course of your trade or business, you may be able to deduct all or part of the cost. You can deduct no more than $25 for business gifts that you gave to any one person during the year.

If you give a customer tickets to a sporting event or theater performance, and you do not attend this event with the customer, you may treat the cost of the tickets as either a gift or an entertainment expense, whichever is to your advantage.

In order to qualify for a deduction for use of your home for business, you must meet several requirements.

You must use a specific area of your home exclusively for business. The only exception to this rule is an area of your home used for storage of inventory or product samples. If a storage area is sometimes used for personal purposes, it may still qualify for the home office deduction.

You must use this specific area of your home regularly for business. If your business use of this area is only occasional, it will not qualify for the home office deduction.

This area of your home must either be your principal place of business, a place where you meet or deal with clients or customers within the normal course of your business, or a separate structure used in connection with your business. The area will qualify as your principal place of business if you use it regularly for administrative or management activities and you do not have another location where you conduct substantial administrative or management activities.

You may deduct a portion of expenses related to the upkeep of your home. The deductible portion of expenses for the upkeep of your home is equal to the percentage of your home that qualifies as a home office. Expenses for the upkeep of your home include real estate taxes, mortgage interest, insurance, rent, repairs (for the entire home), security system, utilities, and services such as trash removal and cleaning.

Expenses that are only for the business part of your home may be deductible in full. Expenses that are only for parts of your home not used for business are not deductible.

There is an income limitation on the home office deduction. Home office expense may only be deducted up to the amount of net income from the business before the home office expense. In other words you can not use the home office deduction and claim a loss on the business. If you are not able to use the home office deduction to the limitation, the amount disallowed will carry forward and may be deducted in future years.

When doing your tax planning for the year, consider the following:

1. Funding a retirement plan may decrease your taxes.
2. If you operate as a sole proprietor or a partnership, you can pay your minor children to work for you without subjecting them to self-employment tax (must be a reasonable wage and documented).
3. As your business grows, you may be better off conducting the business under a different form of entity (i.e. LLC, S-Corporation).