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Self-employment a great shelter -- even without revenue

Self-employment is one of the last great tax shelters, but 2004 has passed so it's too late for self-employment for 2004. Or is it?

You see, many believe they can't possibly report self-employment activities on their 2004 tax return if they didn't have any sales or revenue in 2004.

But hold on. Regardless of whether or not you had any revenue in 2004, you may still be entitled to claim expenses. Now, it must be the case that you had an intention to start a business in 2004, but there's no requirement that you had to have earned revenue in 2004 to be entitled to claim business expenses.

Whether you had the intention to start a business in 2004, or are developing that intention today -- after the fact and in the face of needing tax deductions -- is hard for anyone but you to determine.

The deductions

Any deductions in excess of revenue will give rise to a loss from your business. This loss can be applied against any other income you might have.

To be allowed deductions you must have a reasonable expectation of profit from your business. This doesn't mean you must report a profit every year, but you must expect your revenue to be more than your expenses over the length of time, perhaps years, that you plan to run the business.

What expenses can you deduct? Any costs incurred for the purpose of earning income from your business, including many things you're paying for anyway, are allowed. A portion of mortgage interest, property taxes, landscaping, vehicle costs, meals and entertainment, and tax preparation fees come to mind.

Be aware that home office costs can reduce your business income to zero, but can't create or increase a loss from your business. So, excess home office costs can be carried forward indefinitely.

Another benefit of reporting self-employment activity on your tax return is that your deadline for filing, and your spouse's, is extended to June 15 each year.

The courts

In order to deduct home office costs, you've got to meet one of two tests: Either your home office must be your principal place of business, or your home must be used on a regular and continuous basis for meeting clients. It's tough for most to meet the second test.

In the case Jenkins v. The Queen, the Canada Revenue Agency (CRA) denied home office expenses because Mr. Jenkins ran a fishing operation and all the fish caught were sold off the boats at the dock.

Was his home his principal place of business? CRA said no.

The court sided with the taxpayer because the home office was where he kept his business records, made up payrolls, answered correspondence and otherwise attended to the business.

The court decided that a "principal place of business" is where the business of the core activity is conducted, not the location of that activity per se. Chock one up for the taxpayer.

Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.

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