Trading Your Way to Tax Breaks

Below is an excerpt from my upcoming third book My Happy Assets - Taking the Last Steps to Financial Independence.

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If you trade enough and run your investments as a business, you may qualify as a trader and gain access to an assortment of tax breaks. Now, you will still get taxed off the top your investments at a capital gains level …

Capital Gains Rates
Holding Period	Capital Gain Rate	Other Requirements
Less than 12 months and a day	Normal tax rate (15% to 36%+)	None
At least 12 months and a day	Max. rate (0% to 15%) plus state rate	None

	Type of Investment	Character of Gain or Loss	Investment/ Business Expenses	Interest Expenses
Trader	Stocks, bonds or options	Capital gain/loss	Business expense	Business interest

But, at the end of the day, you are still running a business so you still get to deduct business expenses after the capital gains hit. You can see from the above chart that a short term investment, anything held less than 12 months and a day will taxed at your normal tax rate, 15% to 36%, and anything held longer will get hit at rates from 0% to 15%. In the second table, you see that stocks, bonds and options are taxed at the capital gain or loss rate, business expenses are deductible as business expenses after the capital gains hit, and interest expense is deductible as business interest.

As far as expenses go, achieving trader status means that you can deduct all convention and seminar expenses that are directly related to your trading business and any other reasonable business expenses just like a normal business. The expenses are reported on IRS Schedule C. Additionally, a trading business is not subject to social security taxes unlike most typical businesses.

How to Qualify as a Trader

The bottom line on this is that the IRS does not have a strict definition for a “trader” but there are plenty of court cases … it’s not good enough to merely put a lot of time into managing your investments, you must also trade frequently. You must “trade securities on a frequent and regular basis in order to catch the short-term market swings. In one case, 75 transactions was deemed not enough. In one case, 332 transactions worth a total of $3.2 million was deemed “trader” status. Additionally, your trading needs to be year round, not just during a small window of time during the year. Also, a substantial amount of your income cannot come from dividends, interest and long-term capital gains regardless of the number of trades. You also need to be the money manager, working 100 hours per year more than anyone else or working at least 500 hours per year and should be making all purchase and sales decisions. Again, file expenses on the Schedule C.

Trader Business Expenses … Deduct Away!

· Accounting and bookkeeping fees

· A portion of your home expenses

· Car expenses allocated to your business

· Subscription to investment publications and newsletters

· Books on investing, trading and security analysis

· Seminars on investing, trading and security analysis

· Video and audio tapes on investing and on security analysis

· Tax advice

· Equipment depreciation for business (computers, calculators, cell phones)

· Any investment reporting service

· Salaries of assistants and helpers

· Brokerage fees

· Meals and entertainment of analysts, brokers and other related people

The Game of Covered Call Options Part Deux

Below is an excerpt from my upcoming third book My Happy Assets - Taking the Last Steps to Financial Independence.

If you like what you read, check out my first book, My Happy Assets at http://www.myhappyassets.com/ only $1.99 and the complete second book, Small Business Coffee Hour, Three Essential Ingredients for a Successful Business at http://www.smallbizcoffee.com/, only $1.99. Happy Reading!

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This is how covered calls work in a nut shell: you own 100 shares of a stock, let’s say Microsoft which you bought at $30. You sell 1 option contract against this stock giving someone the right to buy the stock for $30 at the end of the month. For selling this right, you receive a premium of $1.35 or one hundred and thirty-five dollars total since each contract represents 100 shares of stock.

Important Note: 1 option contract = 100 shares of stock.

The buyer of the option is banking that Microsoft stock will increase over the coming month and be worth more than the $30 strike price of the option contract. If it is, their contract will have value since for example, if the stock goes to $31, they now have the right to buy it at $30.

The seller of the option contract is focusing on the cash flow that the premium is delivering. In this case the seller received a 4.5% rate of return on their money or $135 for the $3,000 investment.

Of course, the risk in this whole deal is that the stock drops like a rock. Of course, if you are already invested in single stock, then you are already here. You could combine Buffettology, the Buffett style of investing in which you purchase fundamentally sound companies with strong, consistent earnings, with covered calls. If you apply the Buffett method correctly then your stocks should appreciate over time

even if “Mr. Market” goes haywire. Again, if you are already in single stocks then you are already here. The difference is that now you will be writing covered calls against your stocks which decreases your cost basis in the stock while delivering cash flow.

Of course if you are in mutual funds then you are not at the same risk platform that I am recommending here. You will see that the technique I follow recommends that you diversify across sectors in a maximum of 20 stocks. This can get you closer to “mutual-fund” like investments and not the complete riskiness of non-Buffett single stocks, but remember, you will not be completely here since mutual funds can potentially hold hundreds of stocks.

Still, if you already hold stocks then you are already invested in stocks nonetheless then covered call options will not be much of a leap. If anything, they should make perfect sense to the cash flow investor since writing covered call options will now allow you to generate monthly income, much like rental property. Remember, your stocks are like little duplexes and the income derived from them via covered calls will more than likely beat your current returns through dividends and capital which gains which probably cap out at 10%. If you are as good as Warren Buffett then you should be able to generate a rate of return of 24%. Our method purports to beat this through covered call cash flow.

The following chart is the Covered Call Process Flowchart as presented by Joseph Hooper and Aaron Zalewski in their book Covered Calls and Leaps - A Wealth Option. I highly recommend you purchase this book and study this technique. Joe Hooper has been refining this methodology for over 30 years.

Where his method really excels is through the management of positions that “have not gone your way.” This is the whole crux of the plan because remember, the worst case scenario is that the stock drops like a stone. Hooper and Zalewski claim that through their system, you can continue to generate 3 to 6% a month in cash flow or 36% to 72% even if the stock drops. They have developed techniques, that will generate cash flow even if the stock is heading down.

The best analogy for this technique is found in rental property. If you have a four-plex that delivers $500 a month in cash at drops in price, say you purchased it for $150,000, the bottom drops out of the real estate market and it is now worth $75,000, but it still delivers the $500 a month in cash flow, would you sell it? If the $500 made your mortgage payment, would you sell the rental because the underlying asset price dropped in half?

The easy answer is no, correct? Many would argue that the real estate market is much less volatile than the stock market. Although recently, some real estate markets experienced drops of 50%, it is not likely that property is going to roller coaster like stock prices do. On average, property will make the slow climb at 4 to 6% a year. (can anyone say inflation?) Stocks on the other hand, are fairly manic depressive. Bad holiday retail season … market down. Decrease in the jobless number … market up … maybe, depending if analysts already factored this in. A company meets earnings … stock can decrease if analysts think they can’t do this again.

So you see, the market in many ways is ridiculous unlike, in theory, like the value of a piece of property which in general, in normal times, holds its value. The entire focus and the success of the Hooper/Zalewski plan relies on the ability to continue generating the same amount of cash flow regardless of the underlying value of the stock. This cash flow focus is the focus of our cash flow investing methodology which leads to financial independence.

Now Warren Buffett believes in ignoring the manic depressive nature of the market and buying into good companies with a solid history of earnings, a consumer monopoly or a toll bridge and the ability to reinvest those earnings and continue to compound them. Again, if you are an expert Buffett type investor, perhaps you just buy good companies that will increase in value over time and ignore the market.

I will go into detail on the individual decision points in the chart later but for now, here is the overview.

The Game of Covered Call Options

This is how covered calls work in a nut shell: you own 100 shares of a stock, let’s say Microsoft which you bought at $30. You sell 1 option contract against this stock giving someone the right to buy the stock for $30 at the end of the month. For selling this right, you receive a premium of $1.35 or one hundred and thirty-five dollars total since each contract represents 100 shares of stock.

Important Note: 1 option contract = 100 shares of stock.

The buyer of the option is banking that Microsoft stock will increase over the coming month and be worth more than the $30 strike price of the option contract. If it is, their contract will have value since for example, if the stock goes to $31, they now have the right to buy it at $30.

The seller of the option contract is focusing on the cash flow that the premium is delivering. In this case the seller received a 4.5% rate of return on their money or $135 for the $3,000 investment.

The Four Stages of Financial Independence

Below is an excerpt from my upcoming third book My Happy Assets - Taking the Last Steps to Financial Independence.

If you like what you read, check out my first book, My Happy Assets at http://www.myhappyassets.com/ only $1.99 and the complete second book, Small Business Coffee Hour, Three Essential Ingredients for a Successful Business at http://www.smallbizcoffee.com/, only $1.99. Happy Reading!

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There are four, overall stages along the path of financial independence. Each stage builds upon the other much like algebra. As you move further along the path, your financial picture becomes a stronger foundation.

Defense and Security

This stage provides for food, clothing and shelter and really, nowadays, you should include health insurance here as well. If you lost your job at this point, your passive income will allow you to survive, the necessities will be covered. The benchmark at this stage is having enough passive cash flow to cover your monthly expenses. If, for example, you have $3,000 a month in expenses and $3,000 in passive cash flow from covered calls, dividends and rental property, then you have arrived at stage one. Technically at this point, you are financially free but in order to have greater riches that will allow you to give more money away, buy more toys and have control over your time, you need twice the amount of monthly expenses in passive cash flow which brings us to stage two.

Having a Chair When the Music Stops

Stage two is about two things:

1.) Having twice the amount of monthly expenses in passive cash flow. (for example: with expenses of $3,000 you will need passive cash flow of $6,000 a month to fulfill stage two.)

2.) Ensuring that you have a nice chair to sit in once the music stops.

As I stated previously, “having a nice chair” means the ability to buy luxuries over and above the essentials and allows you to indulge in a passion that you truly enjoy instead of a job, unless of course you love your job. Stage two is all about building a nice place to sit once the music stops and making sure you enjoy sitting there. In many ways, the fulfillment of the nice chair analogy ensures that if you left your job today, you wouldn’t be bored and would have the means to indulge in passionate work. Again, if you enjoy your job then by all means keep it.

Also, it is perfectly plausible for one to become completely financially independent say through property managed, passive cash flowing rental property, which would allow you to sit around and fart in a bathtub all day. Some would enjoy this. Many would not. The real questions are: would you go back to work? Would you keep your job? Would you turn a hobby into a small business? Would you to devote more time to family and charitable work? Is the financial independence structure working, e.g. is the cash still flowing in? This is the main focus of taking the last steps to financial independence and the focus of the second part of this book which will help you evaluate these questions.

Attaining Control, Ultimate Freedom and Riches

As I stated in the introduction, stage three is the ultimate goal of the financial independence path. Once the necessities have been taken care of, (food, clothing, shelter and health insurance) and a nice chair to sit in once the music stops has been built, (twice your monthly expenses) it is time to increase your wealth even more, give more away, spend more time with family, indulge in other hobbies, turn your hobby into a business, buy more toys, volunteer. Stage three is the point at which you have at least $10,000 a month in passive income flowing in from assets, if your expenses are $3,000 a month. What follows are the common size definitions for the progressive financial independence stages.

Stage 1: Monthly Passive Income = Monthly Expenses

Stage 2: Monthly Passive Income = 2X Monthly Expenses

Stage 3: Monthly Passive Income = 3.33X Monthly Expenses

Stage 4: $100,000 in Monthly Passive Income

Examples:

Stage 1: An individual has $1,000 a month in expenses and $1,000 in monthly passive income from dividend paying stocks.

Stage 2: An individual has $3,000 a month in expenses and $6,000 monthly income from a combination of rental property, dividend paying stocks and covered call options

Stage 3: An individual has monthly expenses of $3,000 a month and passive cash flow of $10,000 a month from a combination of assets; rental property, dividend stocks, covered call options, a small business writing and publishing books.

Stage 4: In addition to the assets mentioned in stage three, an individual generates $100,000 in monthly passive income by adding book royalties, IP licensing income, and a big business to the cash flow pot.

As you can see, there is a stage four of $100,000 a month in passive income which truly is the land of ultimate riches. This is a far-reaching goal that should be kept on the radar screen but is outside the scope of this book. As you can see, the first three stages are tightly grouped cash flow-wise and are thus the within the focus of Taking the Last Steps to Financial Independence.

Evaluating Rental Investments - The Gross Rent Multiplier

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The gross rent multiplier is your “rule of thumb” metric that you can use to quickly filter out bad property investments. You should be able to quickly run this ratio and decide if the investment is worth taking a further look or not. The gross rent multiplier is found simply by taking the Sales Price of the property and dividing it by the Gross Yearly Rents

GRM = SP/GYR

As a rule of thumb, anything over 8 is difficult to cash flow from.

For example, let’s say you come across a four-plex for sale at a list price of $170,000. The units rent for $500 a month or a total of $2,000 a month. Yearly this would equate to $24,000. To find the gross rent multiplier, you simply take the sales price of $170,000 and divide it by the yearly rents of $24,000 to arrive at 7.08. This property warrants a further look.

A Discussion About Turning Capital Gains Into Cash Flow

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As long as you have a way to systematically withdrawal money in order to pay the bills then this is cash flow. Warren Buffett likes the companies he invests in to reinvest earnings instead of paying out dividends since they can generate a better return on equity (20% or greater) than other investments. Although it would follow that one should leave capital gains in the holding as well, it seems that you could cash out a portion on a regular basis to generate cash flow while the company still reinvests earnings.

Again, you could still classify this as captial gain move if you wanted to leave the gains in place to continue compounding (again, a Buffett-style investment is not like a mutual fund investment. Over the long-term, the business fundamentals, earnings, management and consumer monopoly will win out over the casino-like Mr. Market and provide a consistent rate of return.)

I still say the definition of cash flow is the ability to generate cash flow on a short term basis in order to pay expenses. Not to discredit capital gains, you need both, but there is a difference ... unless of course you can make the argument that you can let a gain grow and compound for up to ... say, 5 years and then cash out the gain for cash flow. This of course means you need living expenses for 5 years until you can receive the cash flow.

As far as the role Berkshire Hathaway plays in the Buffettology system ... to be honest, I am in the middle of Buffettology Buffetology **ISBN: 9780684871714**
.. it is a great book and a must read for any business person or investor ... but I am not 100% sure what role Berkshire plays. From what I know, it is a holding company for the businesses Warren owns. So I would assume he has tax advantages by using Berkshire as the holding company, etc.

As to why Warren Buffet is not in Real Estate and yet made it to top 3 position of world richest man I would have to counter that neither is Bill Gates ... both are in businesses ... but I believe the Sam Walton clan has significant real estate holdings!

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How to Get Money Out of Your Property Tax Free

Below is an excerpt from my upcoming third book My Happy Assets - Taking the Last Steps to Financial Independence.

If you like what you read, check out my first book, My Happy Assets at http://www.myhappyassets.com/ only $1.99 and the complete second book, Small Business Coffee Hour, Three Essential Ingredients for a Successful Business at http://www.smallbizcoffee.com/, only $1.99. Happy Reading!

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How to Get Money Out of Your Property Tax Free

In my first book, My Happy Assets, I detailed one of the key pros to investing in real estate and that is how to get money out of your property tax free. This is one of the methods you can use in property investment that will turn your income into zero percent money. One thing you must keep in mind though when refinancing an investment property is to evaluate what the cash flow picture will look like after you refinance.

An example:

You originally bought a $100,000 property cash flowing at $250 a month with a $429 loan payment. (a 30 year fixed rate at 5% with a 20% down payment and a principle amount of $80,000). After five years, through improvements to the property and appreciation, the property is now worth $150,000. The bank will give you up to 80% equity in a new loan. So after five years, you have $76,537 equity in the property:

• You have paid down the original mortgage to $73,463
• The value of the property is now $150,000
• $150,000 – $73,463 = $76,537

Thus, the bank will give you $61,230.

If you add this new amount to the balance of the original mortgage, your new loan is $134,693 ($61,230 + $73,463) which results in a payment of $723. Thus, your positive cash flow of $250 becomes a negative cash flow of $44!

• The new payment minus the old payment gives us a difference of $294:

$723 - $429 = $294

• This difference minus our cash flow gives us a negative cash flow of $44:

$294 - $250 = ($44)

You may want to consider not refinancing the full 80%. If you merely refinanced 50% of the equity you would still get to withdraw $38,268.50 tax free while incurring a new payment of $600 allowing you to continue cash flowing at $79 a month:

• Your new loan is $111,732 ($38,269 + $73,463)
• Thus, your new payment is $600
• Thus, your cash flow is $79

$600 - $429 = $171

$250 - $171 = $79

Remember, that tax free money equates to $76,537 in earned income since by the time all is said and done, earned income is taxed at 50%.

Again, the detail of this information can be found in my first book, My Happy Assets available at myhappyassets.com.

Your New Pal - Cash on Cash Return

Below is an excerpt from my upcoming third book My Happy Assets - Taking the Last Steps to Financial Independence.

If you like what you read, check out my first book, My Happy Assets athttp://www.myhappyassets.com/ only $1.99 and the complete second book, Small Business Coffee Hour, Three Essential Ingredients for a Successful Business athttp://www.smallbizcoffee.com/, only $1.99. Happy Reading!

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Calculate the Loan Payment in Cash on Cash Return

This is the end to the means. The cash on cash return or return on investment is the all important number and will be used by you going forward not only to evaluate rental property deals, but also in evaluating additional potential investments across asset classes. Eventually, you will develop your own personal hurdle rate. Mine is 30% and I would be hard pressed to accept any deal, whether in real estate, stock or business that does not deliver a greater return than this. Warren looks at company earnings when evaluating an investment. This is his expected rate of return. Three dollars of consistent earnings on a $10 stock is a 30% rate of return.

Your cash on cash return in the property investment will be your monthly net income (all expenses removed including the loan payment) multiplied by 12 and then divided by your cash put into the deal, typically your down payment.

Cash on Cash Return = (Net Monthly Income x 12) / Down Payment

So, for example, if you are cash flowing $250 a month from a rental property and you have a down payment of $20,000 in the deal, you would have a 15% cash on cash return.

$250 x 12 = $3,000

$3,000/$20,000 = 15%

This metric will help you decide between properties. For example, if you are evaluating two properties, one with a 15% cash on cash return and the other with a 25% cash on cash return, then all things held equal, you would select the property with a 25% return. Of course if this doesn’t meet your hurdle rate, then you might want to continue looking. In your search you should apply the 100:10:3:1 ratio: You look at 100 properties, make offers on ten, three are accepted and you buy one. Also, don’t forget about phantom deduction add-backs. Tax savings through depreciation will provide phantom cash flow … this is an add back that you can use to calculate your rate of return, although I recommend using the before phantom cash flow number as your decision basis and then viewing phantom add-back as the icing on the cake.

Reduce Your Tax Bite Legally

Below is an excerpt from my upcoming third book My Happy Assets - Taking the Last Steps to Financial Independence.

If you like what you read, check out my first book, My Happy Assets at http://www.myhappyassets.com/ only $1.99 and the complete second book, Small Business Coffee Hour, Three Essential Ingredients for a Successful Business at http://www.smallbizcoffee.com/, only $1.99. Happy Reading!

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This Is What You Can Deduct

“Small business people can deduct with proper documentation their house, their spouses, business vacations, food with colleagues.” – Sandy Botkin, Lower Your Taxes Big Time.

The first item to address is business losses and the chief question as it relates to this area: must you show a profit every year in order to qualify as a small business and take deductions? The answer:

If your business produces a loss in the first year, you can use that loss against any other income you have. It can be used against wages earned as an employee, dividends, pensions, interest income or against spouse’s earnings if filing jointly.

Example: Mike makes $50k at a regular job and has a small business loss of $10k. He thus pays taxes on $40k.

So, the answer is, typically, in order to audit proof your small business, you need to show a profit three out of five years. You can apply business loss against your ordinary income.

Meals and Entertainment

Meals and Entertainment deductions are one of the most approachable business deduction categories for small business owners. With adequate documentation and by following business protocol, described below, you will be able to turn your meals into legal, tax deductible business meals.

First, some highlights on the percentage of deductibility for meals and entertainment:

· Entertainment expenses are typically 50% deductible.

· If you report the full amount make sure to tell your accountant it is 100% of the expense.

· No receipts are needed for entertainment expenses under $75 but keep all business expense receipts regardless.

· You should pay attention to the amount you can deduct. Don’t report the full amount and think you are still following the rules. Meals are 50% deductible.

Also, there are rules of road to follow in order to categorize a meal as a business meal.

“A business meal must be prearranged for the purpose of conducting specific business. Your prospect must reasonably expect a business reason for the meal or entertainment.” – Botkin

As a result, you can’t just simply run into Joe at Red Lobster, sit down and munch on shrimp scampi with him and then count it as a business meal. You would need to call Joe up before going to lunch and tell him you want to discuss business. This action would qualify the meal as a prearranged business meal.

You must discuss business before, during or after a business meal to qualify for the business meal deductions and it must be with a legitimate prospect. For meal expense audit proofing, you should have a document that details a clear and specific business discussion. Also, the meal must take place in surroundings conducive to a business discussion e.g. a restaurant. A restaurant or a movie theater would not be conducive.

Again, although receipts are not required for purchases under $75, you must document your meal or entertainment expenses adequately. There are 5 main questions that need to be answered in your documentation in order to audit proof your meal:

1) Who was entertained and what is the business relationship?

Identify the person or persons, name, occupation, official title and other corroborative info to establish the business relationship.

2) Where did it take place?

A receipt will substantiate this requirement. The nature and place must also be described.

3) When did the entertainment take place?

Note the date and time in a tax diary or again, the receipt should detail this.

4) Why did the entertainment take place?

Note the business purpose – state the exact nature of the business discussion or activity. Example: “Talked about using my services including consulting on property investment.” Be brief but be very specific.

5) How much did it cost?

Again, a receipt will cover this.

Also, the IRS would prefer that you record these answers in a timely fashion. You can’t wait a year and then go back and backdate the documentation. Plus, it would not be an easy task.

In addition, if your spouse is not an employee of your company, his or her meal can still be tax deductible if you bring them along in order to entertain an opposing spouse of a business couple. This is called the “Dutch Treat” rule. Here’s the example: you meet with Ralph to discuss business at TGI Friday’s. Ralph brings along his wife Betty and you bring along your wife Sally. During the meal, Sally talks with Betty while you and Ralph discus pork futures. Your spouses’ meal would thus be 50% tax deductible along with yours.

Just make sure to name the other couple in your documentation. One method to log and archive the preceding pertinent information is to simply write on the back of the receipt and to keep the receipt.

Associated Entertainment/Goodwill Entertainment

Another form of tax deductible entertainment is associated entertainment. Associated entertainment takes place in a non-business setting that precedes or follows a substantial and bona fide business discussion during the same day as the entertainment. Thus, if you follow-up your TGI Friday lunch with a round of golf, the green fees would be considered associated entertainment and would therefore be 50% deductible. Furthermore, it would not be necessary to discuss business on the golf course. This is not a requirement necessary for associated entertainment deductibility. The golf must merely be preceded or followed by a business discussion.

To audit proof your golf round or other associated entertainment, you must have a link showing that you discussed business either before or after the event on the same day.

For a thorough tax diary that will aid you in documenting all of the necessary details, go to Sandy Botkin’s website at:

www.taxreductioninstitute.com.

Although keep in mind, the back of the receipt should provide enough writing room.

Other associated entertainment location examples include:

· Night Clubs
· Theaters
· Sporting Events

Yes, season tickets to a sporting event or other form of entertainment venue can be tax deductible but the percentage of deductibility is based on the ratio of how many games are used for business purposes. For example, if you take a client, Ralph, to eight out of ten hockey games, you would be able deduct 80% of your season tickets.

At this point, Ralph is a happy camper since he got to eat TGI Friday’s, play a round of golf and attend a hockey game.

Charity Events

Yes Virginia, you can deduct charitable donations.

If you buy tickets to a charity ball, the tax deduction for the event would not be limited to the face value of the ticket if three conditions apply:

1. The event is organized for the primary purpose of benefiting a tax exempt charity.

2. All net proceeds of the event are contributed to a charity.

3. The event uses volunteers for substantially all the work performed in carrying out the event.

So in essence, it truly has to be a charity event. Also, if you make a business gift, you will hit a $25 ceiling deduction but gifts made to an entire department within a business are tax deductible. This means you can send an entire fruit basket to your favorite IT department at XYZ Corporation or organization and the entire basket would be deductible. Ideally you would send it to the department that employs Ralph so you can ensure he is still living high on the hog.

If you gave a gift of entertainment such as tickets to a concert, they would be 50% deductible.

Home Entertainment

How much home entertainment can be deducted and where is the line on this category? Are we starting to cross a line here? The answer is no. Again, by following the rules, maintaining accurate, detailed documentation and by consulting a professional accountant, you should have no fear about the types of deductions you can take.

Yes, you can deduct home entertainment:

Example: Sam has a five minute discussion about referrals while entertaining friends at his home. One of the friends of course is Ralph. Sam can deduct 50% of the party but I still must emphasize that he had to discuss specific business. As a rule of thumb, the number at the party should be kept under 12. Anything above serves as a red flag to your friendly IRS auditor.

Also, never combine a personal event with a business event. This is a big no-no. Example: writing off your two year old’s birthday party by discussing specific business with the other tots’ parents. This does not count.

But, you can give a sales presentation at your home and the food served can be 100% deductible for the seminar/presentation. Just make sure you answer the five questions – who, where, when, why and how much money – and document, document, document.

Entertainment Recap

1. Discuss business when you eat and document who, where, when, why and how much. Make sure this is a premeditated business meal.

2. Deduct theater tickets, golf fees, movies, sports tickets and other associated entertainment if they are preceded or followed by a legitimate business meeting.

3. Deduct season tickets by taking clients (Ralph) to games. Only deduct the percentage of games you took him to.

4. Deduct your spouse’s food and entertainment expenses if it falls under the “Dutch Treat” provision where he or she is entertaining another couple.

5. You can also deduct entertainment at 100% if it is considered business promotion – a professional movie critic who goes to the movies to write a review or a golf pro who plays a round of golf with a client would qualify under this rule.

6. Deduct at home entertainment expenses by discussing specific business at small parties or by giving a presentation or sales seminar. And don’t try to deduct your two year old’s birthday party – Ralph would be ashamed.

Vacations

A vacation can be deducted if it is combined with the appropriate amount of business thus qualifying as a business trip. Vacations or business travel can be a great source of tax deductions (and fun). Of course, this is the area you want to make sure you cross your Ts and dot your Is documentation-wise.

As a rule of thumb, an overnight business trip is a trip that requires you to sleep overnight on the trip. To qualify a trip as a business trip, the majority of days spent on the trip must be for a business purpose. To qualify a day as a business day, your presence must be required for part of the day for a bona fide business purpose. For example, you deliver a document to a business partner. This would qualify as a business day. Or say you are in San Francisco and you attend a 30 minute meeting with an investment property realtor. This would qualify as a business day. For someone in the property investment business, you can spend the rest of the day sightseeing or traveling across the golden gate bridge while still maintaining business day status. Also, you must make sure that the majority of your days are business days in order to activate the business trip status.

Example: You go for a five day trip to Denver, Monday thru Friday, with meetings scheduled on Tuesday and Wednesday. Since Friday is considered a travel day, and Tuesday and Wednesday are business days because of the meetings, the trip would be considered a business trip since the majority of days, three out of five, are business days.

In addition, the IRS counts weekends sandwiched in between business days as working weekends thus, the sandwiched weekend days count towards the business day majority criteria even if you spend the days surfing.

Example: You go to Hawaii for seven days, leaving on a Thursday with meetings scheduled on Friday and Monday. Five out of the seven days will be considered business days and therefore the trip is a bona fide business trip. (Friday and Monday are meeting days with Saturday and Sunday sandwiched in between totaling four business days. The Thursday return is considered a travel day for a total of five. Thus, you meet the majority business day criteria.)

This is what it looks like table-wise:

Document, Document, Document

The chief tactic to make your business travel audit proof is to schedule appointments in advance and keep the documentation proving that you made and kept those appointments. For example, if you e-mail a real estate office setting up an appointment in order to discuss investment property, you need to print and keep your sent e-mail as well as the acceptance reply you receive from the realtor. Also, when you meet with the realtor, make sure to grab his or her business card along with sample property listings in order to substantiate the business meeting.

The Expenses That Can be Deducted

If it is a business trip, you get to deduct 100% of

· Hotels on business days
· Dry cleaning
· Tips

● 50% of food on business days.

Transportation Expenses

These are costs incurred traveling on the road to and from the destination; airfare and car costs. One hundred percent of transportation expenses are deductible on a business trip.

On the Road Expenses

As a rule of thumb, these are all costs necessary to sustain life on the trip and include lodging, meals, laundry, dry cleaning. You can deduct the first laundry and dry cleaning expenses when you get home as long as the clothes were soiled on the trip … so get to soiling!

· You are allowed to deduct on the road expenses for each day you are on business travel status. You may deduct 100% of on the road expenses but when it comes to meals, only 50%.

· You may not deduct the cost of entertainment not associated with a business nature or prospecting.

· To make your spouse’s business travel expenses tax deductible, hire her or him as an employee of your business. Otherwise you deduct the cost of one.

· All of your business car expenses are deductible, even with non business riders.

· Deduct a hotel at the single occupancy rate if you are the only deductible one on the business trip. Grab the rate card off of the back of the door for documentation purposes.

Business Trip Expense Recap

Again, clear business intent must be established before you leave for the trip. Make sure to hold on to copies of e-mails for appointments made at least a few days prior to departure noting the day time and place of the scheduled meeting. Also obtain documentation that proves you were there – business cards and paper work. Again, document, document, document.

Also, remember also that more than one half of the days must include either:

• Business travel
• Appointments for at least 30 minutes
• A weekend sandwiched in between
• Document delivery

So, if you are gone for 7 days, Friday thru Thursday with meetings scheduled on Friday and Monday:

Because of this status:

• 100% on the road expenses are deductible(hotel, dry cleaning, tips)
• 100% travel expenses (airfare, car rental)
• 50% on the road expenses (applies to food)

To audit proof your travel, document the following:

1.) The amount that you spend daily for such things as

transportation, meals and lodging.

2.) The dates of your departure and return home from each trip and

the days spent on business while away from home.

3.) Where you traveled. Describe the name of the city, town or similar

destination.

4.) Why you traveled, including the business reason for your travel or

the business benefit derived or expected to be gained. (as specific

as possible)

5.) The preexisting business intent: correspondence sent to

prospects, documented phone calls, appointments in advance, etc.

Home Office

According to Soliman vs. the US Supreme Court – the leading precedence on home office business deductions, anyone who truly works out of his or her home and performs his or her most important functions at home can take the home office deduction. This would include network marketers, freelance writers, musicians who do most of their practicing at home and consultants who do most of their important work out of their homes.

First and foremost, your office must be used solely for business purposes. You cannot have a guest bed, a book shelf containing books not related to your business a treadmill nor a box of the kids’ toys just to name a few examples. The IRS is pretty stringent about this and yes, it is possible that they will check and disallow your deduction if you do not meet the requirement.

There are three methods that you can use to figure out how much you can deduct.

• Method One: the amount of office square feet divided by the total usable square footage of the house.

• Method Two: the number of rooms the office occupies divided by the total rooms in the house.

• Method Three: net square footage method (similar to method one except you subtract out the common areas such as hallways, entranceways, landings and stairways.)

Run the numbers and use the approach that leads to the biggest deduction for your situation. You might want to consult your accountant on the home office business deduction since you run into home depreciation recapture complications when you go to sell your home if you take this deduction.

Also, don’t forget that you can deduct more rudimentary things such as office supplies, internet connection, the cell phone used for business. These are more of your straightforward, typical business deductions and should not be subject to intense scrutiny. Still, keep those receipts.

Audit Proofing, Recapping and of Course, Ralph

Just to restate the initial premise of why you should turn your hobby into a small business, the rich are getting richer through legal, justifiable tax breaks via their businesses and now, after reading this piece you can do the same. By aggressively shifting as many of your personal expenses into legitimate business, tax deductible expenses, you can take advantage of a plethora of tax breaks allowing you to retain more income in order to acquire cash flow generating assets that propel you to financial independence at an early age.

By taking action on the information detailed above you can deduct meals and entertainment, associated entertainment, charity events, home entertainment, vacations and your home office. If you are considering starting a small business, these tactics alone will give you an immediate initial leg up in your venture. You will already be employing a money making strategy off the bat or at least, a money saving strategy. If you are looking to increase your net worth or cash flow, this strategy of starting a small business will allow you to keep more of your income in order to build your assets.

Audit Proofing

In real estate the most overused, clichéd, expert advice is “location, location, location.” In small business tax deduction strategy, it is “documentation, documentation, documentation.” If you are going to be aggressive about your tax deductions (and you should be) then you need to ensure you can sleep well at night by having ample documentation to backup your deductions.

Documentation Requirements:

• Keep All Receipts

Although you are only required to keep receipts for expenses over $75, keep them all. I like to keep all receipts, personal and business, noting on the receipt whether it is personal or business and then what category it falls under. According to Robert Allen in “Multiple Streams of Income,” by doing this, in addition to verifying that the receipt is accurate, you can save tons of money over the years.

• Log Your Time

If you are promoting a hobby up to a business, keep a business journal denoting what date you worked on your business, how much time you spent and what activity you performed. The whole key here, along with creating a business plan and financial projections, is to prove you are running your business as a business. One of the biggest tactics of the IRS is to classify your business as a hobby thus disqualifying most, if not all of your deductions. You want to insure against this by documenting the time you spend in the business and don’t backdate a journal at the end of the year. Log it as you go along.

Also, it is better to work an average number of healthy hours per week, say 15 to 20, rather than cramming in 40 hours all at once at the end of the month. The first example communicates that you are putting steady time into growing a legitimate business. The second communicates that you might not actually be tracking time and instead, bulk loading it at the end of the month, thus a red flag. Don’t do this.

• Audit Sheet for Expenses

As I said earlier, there are five questions you need to answer for deducting business meal and entertainment expenses. Again, these are:

1) Who was entertained and what is the business relationship? Identify the person or persons, name, occupation, official title and other corroborative info to establish the business relationship.

2) Where did it take place? - get a receipt. The nature and place must also be described.

3) When did the entertainment take place? Note the date and time in a tax diary.

4) Why did the entertainment take place? Note the business purpose – state the exact nature of the business discussion or activity. “Talked about using my services – consulting on property investment.” Be brief but be very specific.

5) How much did it cost? A receipt will cover this and can be used to document the information.

Also, you should track travel details including hotels and overnight expenses. For a really great log sheet product, visit Sandy Botkin’s website at www.taxreductioninstitute.com. This site has a tax log product that will help you document the 5 questions for meals and entertainment as well as travel expenses.

• Mileage Log

Business mileage can be tracked in a standard mileage log book available at most local office supply warehouses.

• Documentation for Travel

Again, with business travel, make sure to capture supporting evidence proving business intent for the trip; business appointment e-mails, business cards from the trip, MLS listings, room rate cards, etc.

• Show a Profit Three out of Five years

You can lose money and apply the loss to your regular income but you must show a profit for three out of five years to prove profit intent. If you run it at a loss for many years it will prove to be just that, a tax write off and your deductions will be disqualified.

•Intention to Make a Profit

Documents such as a business plan and a financial plan showing growth and eventual profit, will prove your intentions to eventually make a profit. These supporting documents should serve as the proof in the pudding.