Be alert to this fact: a tax deduction does not mean your taxes are reduced by the total amount of the deduction. Some home business recruiters do not make that clear. They are perfectly happy to allow the recruit to think that a $5,000 deduction for your automobile expense, for example means that your gross tax amount will be reduced by $5,000.  

Here is how it works. You take the $5,000 off your income for that tax year. If you made $50,000 that year your taxable income would be reduced to $45,000. Of course, you would have many other deductions that will cause your adjusted gross income on your tax form to be deeply reduced from the $50,000 gross income. 

Chances are you would end up close to a 20% tax bracket after you take your deductions. Thus, what you actually save in taxes for that $5,000 travel expense would be 20% of $50,000, a savings of $1,000. The fallacy is not plainly spoken by your recruiter is that you will be using your car much more in the business so your overall cash outlay is still a large expense.

Some business deductions touted by recruiters often raise red flags with the IRS. Typically these deductions are:

1. Home office deduction - there was a time when many people took stopped claiming this legal deduction because its very presence on your tax form would, in some cases, be a cause an automatic tax audit. This was because it was so often misused. You must decide if the home office deduction is right for you. Remember that the office must be used only for business purposes. However, incidental use is allowed. For example, you would not lose the deduction if you allowed your son to use your office to study. Consult with your accountant and discuss the benefits vs the liabilities.

2. Entertainment - another legal deduction that you should make you think twice. If you do claim this one be sure to keep a very good paper trail. If you pay anything in cash it will probably be disallowed in an audit.

3. Vacations and Travel - if the deduction is beyond "normal" then you better be ready to back up the reason for your vacation. Sales receipts alone will not be all that you need to show at audit time. You may be asked for other types of proof. 

4. Automobile expense - I was once audited for the deduction I claimed. I did not keep a detailed record of my expenses. When I was in the office with the IRS auditor I told her about my business driving habits every week and determined my probably weekly mileage. We then found that the car, a green Chevy Vega, had a 30 mpg rating. Doing the math, she allowed me a deduction even though I had only a few receipts.

The tax folks are not all that evil after all! In fact, lately they are downright helpful and friendly. But that is no reason to assume they will not drop the hammer on you if you do something way out of line like claim too many dependents or understate your income. I feel that if you believe a deduction is allowed then you should take that deduction. If you are proved wrong, then you will just have to pay the tax that you legally should have paid at the beginning. 

6. Hiring your spouse and children - it is allowed and the deduction is legal 
You can pay your child a few thousand a year for work they performed in your business operation. Usually most of this payment will go into an education IRA in your child's name. This is a great benefit to you and your child but, still, it should not be a valid reason to go into your own business. 

7. Medical reimbursement plan - when I sold insurance I learned to be ready for the phone call when a person who retired before age 65. Those people are not informed about the cost of carrying your own personal insurance. These days that cost can easily be $10,000 per for a husband and wife. If anyone touts this as a "good" benefit for you as a self-employed person call the ambulance for the loon.

8. Self-employment tax (SE tax) is a social security and Medicare tax primarily for individuals who work for themselves. If you are in business for yourself either part or full time, you will have to pay the Self Employment taxes each year you make a profit. Don't underestimate the effect of this tax on your income. The self-employment tax rate is 15.3%. This means that if you clear $25,000 after deductions you will need to send the government $3,825 to cover this tax. This amount, of course, does not include your income tax amount.

9. Remember that if you are married filing jointly, you will get an automatic deduction of $10,300 (2007) whether or not you have your own business. This means that your business deductions would need to total more than $10,300 before any income tax "benefit" would accrue for your business income. The automatic deduction for Single or married filing separately is $5,150 and for Head of Household it is $7,550.

10. Conclusion: tax deductions do reduce your taxable income for the tax year but they should never be a reason to go into your own business. Thinking that way will make you very disappointed if not a financial casualty. 

Having said this, I will tell you that I have been in my own business for many years and I've never regretted it for an instant. I love being my own boss and I don't mind paying the taxes I owe.

A good tax accountant is worth his or her weight in gold. Be sure to get the advice you need from your consultant.

My wish to you is that you will pay $1,000,000 in income tax next year!

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