If you use part of your residence for business purposes, you may be able to deduct part of your office-in-the-home expenses, however the rules are rather stringent.

There are several types of situations under which you may be able to claim deductions for part of your rent or expenses related to ownership of your residence, as well as other occupancy expenses, despite the home-office deduction limitations.

If you use part of your residence exclusively for business purposes and on a regular basis, you may be able to claim office-in-the-home deductions, if you qualify under one of these tests:

• You use a portion of your home as you principle place of business.
• You use your home as a place to meet clients, customers, or patients.
• Your home office is a separate structure that is not attached to your house or living quarters.

The rule for determining whether your home is your principal place of business now depends on two primary considerations:

• The relative importance of the activities performed at each work location
• The amount of time spent at each location

Two special exceptions are sometimes made where part of the home is regularly, but not exclusively, used for business purposes:

• Storage of inventory – A wholesaler or retailer who uses part of a home to store inventory that is being held for sale; if the dwelling unit is the taxpayer's sole fixed location of the trade or business
• Day Care Facility – Part of the home is used for day care of children, physically and mentally handicapped persons, or individuals age 65 or older.

No attempt will be made here to go into the intricacies of the estate-planning possibilities that may be available; instead, the fundamental approaches you need to be aware of are outlined below. Please discuss how to relate these concepts to your own situation with your tax adviser and attorney.

A useful method of reducing lifetime income taxes is to split the taxable income from your business between two or more persons or entities. Usually a corporation, particularly an S corporation, is a useful vehicle for doing this; you can split income between you and your children by giving them stock in the corporation.

Often, the best time to remove potential wealth from your taxable estate at death is by giving your children part of the stock in your incorporated business when the business is formed – when the value of the stock is likely to be negligible. If you wait until the business has become a valuable and profitable enterprise, gifts of stock at that time may result in substantial taxable gifts for gift tax purposes, even though the tax cost of those gifts may not be felt until you die, in some cases.

If you have one or more partners or business associates who also own a part of the business, it is very important that you enter into a buy-sell agreement with them. The agreement should spell out what happens if one of you dies, becomes disabled, or wants to sell his or her interest in the business.

The estate tax unlimited marital deduction, enacted by Congress in 1982, says that any assets you leave to your spouse are treated as a deduction from the amount of your estate that is subject to federal estate tax.

If you run an unincorporated business and your spouse works with or for you, there are three ways your spouse can be treated for tax purposes:

• As an employee
• As a partner in the firm
• As an unpaid employee in a family business

Social Security Tax – Congress, by enacting the Omnibus Budget Reconciliation Act of 1987, ended the exemption from Social Security (FICA) taxes for wages paid to a spouse, parent or minor child – with the exception of a child under 18 years of age. There are, however, still some advantages to having your spouse be a paid employee of your proprietorship.

If your spouse works for you without pay and has no other income from an outside job, the most the two of you can put into an individual retirement account (IRA) is $2250. If you start compensating your spouse, even as little as $2000 per year, you should each qualify for a $2000 IRA deduction or a total of $4000 per year, rather than only $2250. (Note: IRA deductions may be limited if either of you are active participants in anther retirement plan.)

You can deduct any medical insurance premiums that you pay for employees, but you can only deduct a limited portion, if any, of your own medical insurance premiums. If your spouse works for you, however, you can put your spouse on the payroll and provide a medical expense reimbursement plan or medical insurance for your spouse and his/her family – which includes you. You can then deduct the payments or premiums in full since your spouse is an employee.

The unemployment tax rate you pay, as an employer is one of the few taxes where you have some control over the rate you pay. The state maintains a reserve account for each employer, in which it monitors the unemployment taxes you pay in and the unemployment benefits paid out to your former employees. The more benefits the state pays to your former employees, the higher your company's tax rate will be and vice versa.

So it pays for you to have as few former employees as possible who are collecting unemployment benefits, since these are charged to your reserve account.

To succeed in keeping down the unemployment claims charged to your account, you need to challenge any former employees' claims that appear to be unjustified. Often, you will be surprised to learn that an employee you had fired for stealing or who had quit on you has filed for benefits and has lied about his or her reasons for leaving. In general, an ex-employee can't collect unemployment for you if he or she left your employment for one the following reasons:

• Refusal to work
• Voluntarily quitting
• Inability to continue work due to illness or injury
• Misconduct, such as theft, not showing up for work, etc.

An employee who leaves your employ for virtually any other reason, such as being fired for incompetence, can generally collect benefits, which will cost you money by raising your unemployment tax rate.

One of the major advantages of operating your own business is the opportunity it may give you to deduct the costs of certain activities or luxuries as business expenses. Some of these deductions are discussed below.

Travel, Entertainment and Meals: It is possible to deduct business travel expenses, entertainment of your clients or customers, and business related meals; however, you can only deduct 50% of qualifying business meals and entertainment. It is important to keep very detailed records of such expenditures, including bills, receipts, and any other pertinent information. For more information contact your local IRS office and request publication 463, Travel, Entertainment, and Gift Expenses.

Automobile Expenses: If you use an automobile more than 50% of the time for business purposes, you will generally be able to deduct a percentage of the costs of owning and operating the car, but you must substantiate the business mileage. The expense of using the car for commuting to and from work and for personal travel is not deductible. Rules are even more drastic for any automobile, airplane, boat or computer not kept in your place of business if you can't establish a business-use percentage in excess of 50%.

One of the most effective ways to reduce your taxes, in many cases, is to incorporate your business. Incorporation is most likely to be advantageous if the business is generating about $75,000 or less in annual profits and salary for the owner. Three basic ways that incorporation can reduce your taxes on business income are as follow:

Leaving Profits in the Corporation: If you are able to leave your first $75,000 of annual profits in your corporation, the profits will generally be taxed at corporate rates that are lower than your individual rates. This provides a strong incentive to leave at least that much taxable income in the corporation rather than pay it out to yourself as salary.

Income Splitting: By using a corporation, it is possible to split your overall profit between two or more taxpayers, so that none of the income gets taxed in the highest tax brackets. For example, with an overall profit of $100,000 an incorporated business may be able to reduce its taxable income to $50,000 by paying (and deducting) a $50,000 salary to its owner, as an officer/employee of the corporation.

Another way to split the income of a business between multiple taxpayers is for you to make your children part owners of the business. Ideally, the children should be given interest in the business when it is started. It is frequently more feasible to split corporate income with your children by giving them some of the corporations stock. By giving a number of shares of stock in an S Corporation to one or more of your children, part of the taxable income of the business can often be shifted to the children and taxed at their low tax brackets. (Note: this assumes, as is usually the case, that the children do not have a lot of taxable income from other sources.)

Investing in Stocks: By investing accumulated corporate funds in dividend-paying stocks of other corporations, you can take advantage of the 70% deduction that corporations are entitled to on the dividends they receive. Because this special deduction makes most dividends received by a corporation – other than those received by an S corporation – practically tax-free to the recipient corporation, your incorporated business can be an excellent place to hold stocks. Your accountant will probably be the best person to consult for determining how and whether you can use a corporation to reduce taxes on your business profits.

In 1996, President Clinton signed the Small Business Job Protection Act. A few tax savers include:

Simplified Pension Plans: The new law creates Saving Incentive Match Plan for Employees (SIMPLE) retirement plans that may be used by employers with 100 or fewer employees and no other established retirement plan. Under SIMPLE, employees can make deductible contributions to IRAs or 401Ks annually. Employers must match employee contributions under specific formulas. SIMPLE is not subject to the nondiscrimination rules that limit the benefits that can be provided to highly paid employees. The new SIMPLE started in 1997.

Bigger Expensing Deductions: Businesses that purchase new equipment during the year can now elect to immediately deduct up to $17,500 of purchases – instead of recovering the cost of the equipment over a period of years through depreciation deductions. In 1997 the limits are raised to $18,000 and by 2003 the amount will rise to $25,000.

Self-Employed Health Insurance: Currently, self-employed individuals can deduct 30% of the cost of their health insurance. The following deduction percentages will be allowed in the upcoming years: 1997 – 40%, 1998 – 45%, 1999 – 45%, 2000 – 45%. By the year 2006, the deduction should reach 80%.

MSAs: Medical Savings Accounts (MSAs) are tax favored savings accounts that can be used to pay medical bills, as well as earn tax-deferred returns. The new tax laws allow businesses with no more than 50 employees to setup MSAs. Funds that remain unspent in an MSA at age 65 become extra retirement savings, or death or disability benefits.

One advantage of being your own boss, either as a sole proprietor, a partner, or a shareholder of a closely held corporation, is the opportunity to be able to setup a retirement plan.

 There are three types of tax-favored retirement plans:

• Corporate pension and profit-sharing plans
• Keogh pension and profit-sharing plans for unincorporated businesses
• Individual Retirement Accounts (IRAs) 

• Amounts contributed, up to certain limits, are deductible for the income of the corporation or individual taxpayer. This deduction can be as much as 25% of the individual's compensation for the year or $30,000, whichever is less. 
• Contributed funds can be invested by pension or profit sharing plans on a tax-free basis. The qualified retirement trust that is usually set up to hold the retirement funds is exempt from state and federal income taxes on its income or capital gains from investments in stocks, bonds, savings accounts, gold, silver, real estate and other passive investments. 
• When trust funds are paid out to you at retirement, you may be in a lower tax bracket than when you made the contributions to the plan. Not only do you get to defer payment of any tax on amounts contributed to the plan until you retire, but the tax you finally pay at retirement is apt to be at a lower rate then you would have paid when you were working. 
• Receipt of all your retirement plan funds in a lump sum at retirement, or in certain other circumstances, may often qualify for special low tax rates if the distribution is from a corporate or Keogh plan but not from an IRA.

 Medical Insurance Plans: The corporation that maintain a medical insurance plan, such as Blue Cross or a prepaid health care plan, is permitted to deduct the premiums it pays to the insurer. In addition, the employee is not required to include either the cost of the premiums or the benefits provided by the insurer in his or her taxable income.

Self-Insured Medical Reimbursement Plans: A corporation can setup a plan under which the corporation directly reimburses employees for medical expenses or even for such expenses as dental care, orthodontic work, and prescription eyeglasses or contact lenses. If the plan satisfies tax law requirements prohibiting discrimination in favor of highly paid employees, the reimbursements paid can be deducted by the corporation and are not taxable to the recipients.

Disability Insurance: Payment by a corporation of disability insurance premiums is deductible by the corporation and is not taxed to the employees covered by the insurance – except in the case of an S corporation.  

If an employee becomes disabled and receives disability benefits under a policy that the employer has paid the premiums for, the benefits will be included in the employee's income for tax purposes. On the other hand, if an individual, such as a sole proprietor or partner, has paid his or her own premiums for disability insurance, any disability benefits received are tax-free. 

Group-Term Life Insurance: Your corporation may set up a group-term life insurance plan and deduct the insurance premiums it pays on behalf of employees. To the extent the life insurance coverage on an employee does not exceed $50,000 under the plan during the taxable year, the premiums paid by you are not taxable income to the employee. 

Even to the extent an employee's coverage exceeds $50,000, the amount the employee must include in taxable income from the additional insurance premiums paid by you for the excess coverage is sometimes considerably less than the premium actually paid and deducted. 

Unless your business is a C corporation, it cannot deduct the premiums for your own coverage under a group life insurance plan because you are not considered an employee of the business for tax purposes. 

Meals on Premises: If meals are provided on-premises to employees, for your convenience as the employer, the value of such meals is usually not taxable to the employee for income tax purposes, however, you can deduct 50% of the cost of furnishing such meals.

 Educational Assistance Plans: You may pay educational expenses on behalf of an employee – free of employment taxes or income tax to the employee – if the purpose of such education, meets one of the following two tests:

• The education maintains or improves skills required by the job
• The education meets requirements set by you or applicable laws, where such requirements are imposed as a condition of the retention of employment or rate of compensation. 

You may also set up tax-qualified educational assistance plans to provide other – not necessarily job-related – educational benefits for employees, in amounts up to $5250 a year per employee.

 Dependent Care Plans: Dependent care plans are one of the most popular and rapidly growing types of employee fringe benefit plans in recent years, providing up to $5000 a year of dependent care benefits for children or elderly dependents per employee. 

Stock Option Plans: There are a number of different stock options plans with various tax advantages, all of which are designed to encourage employees to acquire a proprietary stake in the companies they work for. Three examples include:

• Nonqualified stock options
• Incentive stock options
• Employee stock purchase plans 

Flexible Spending Plans: The flexible spending, or flex plan, has become another increasingly popular type of tax-favored employee benefit plan. Each of the following three plans is designed to permit employees to choose how much to spend on a tax-free basis for various employee benefits, such as health and dependent care.

• Premium-Conversion Accounts
• Flexible Reimbursement Accounts
• Cafeteria Plans