The 27 words are found at the start of the Internal Revenue Code Section 162. Trade or business expenses.

(2) In general
“There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business…..”

Note: The key words are: “Ordinary and Necessary”

An ordinary expense is one that is common and accepted in the taxpayer’s field of business, trade, or profession.

A necessary expense is one that is helpful and appropriate to the taxpayer’s business.

However expenses are not deductible to the extent they are lavish or extravagant.

Remember this: Everything you do, everywhere you go, and everyone you meet can be related to your business.

For the last 28 years I have worked with small businesses to reduce their taxes and prepare their tax returns. In other words I do tax planning and tax preparation for a living. My clients are one person businesses, mom and pop businesses, full time businesses, part-time businesses, home based businesses, and businesses with many employees and multiple locations. They are the very fabric of today’s economic society.

But regardless the size or type of business that you operate, if you do not understand another word I say, understand this: “It is not what you earn that matters, it is what you get to keep that counts!!!”

In pursuing the dream of lower taxes, it is never necessary to resort to tax cheating, risky loopholes, or even to question the legality of the tax system. There is a big difference between cheating, risky loopholes, and tax reduction strategies.

Tax cheating is understating your income or claiming tax deductions for assets that you don’t own or expenditures that you never made.

Risky loopholes, on the other hand, are gray, mostly untested areas of the tax law that allow you to claim “default deductions” that Congress and the IRS probably would have ruled against had they had the foresight to see the possibilities. Since a specific “no” does not exist, you create a loophole by saying, “yes” to a perhaps a risky deduction.

On the other hand, there are hundreds of government mandated legal tax reduction strategies and deductions. I will teach you many of those legal tax reduction strategies and deductions that you can implement immediately.

Owning a operating your own business is what I call the “last of the great American tax shelters”. There are hundreds of government mandated legal tax reduction strategies.

The question of legality and morality of tax deductions was settled once and for all over 40 years ago by the United States Court of Appeals in an opinion written by Judge Learned Hand.
“Anyone may so arrange his affairs that his taxes shall be low as possible. He is not bound to choose a pattern that will best pay the treasury. No one owes any public duty to pay more than the law demands.”

This decision should govern both your tax plan and your tax attitude.

Rearranging and designing your affairs to create tax deductions where you had none before is the one of the big keys to paying less taxes, legally, ethically and morally.

Think about this, most people spend all they earn anyway, so why not spend the money in a legal, ethical and moral fashion in order to obtain a tax deduction. “Everything is cheaper when you get to deduct it.”

“It is not what you earn that matters, it is what you get to keep that counts!”

Please note: There is not “one” big tax deduction in the sky that will reduce your taxes like you want; it is through the use of combinations of tax strategies that taxes are reduced.

1. You must become the best in your profession. There are those who look the best, talk about the best, expect the best, and perform the best. Guess what they get?

2. You must invest over “40” hours per week.

3. You do not need a college degree. It takes expertise not degrees; it’s what you know and how you use it that counts.

4. You must commit for a minimum of “2” years. For most small business owners it is a 2 to 5 year business-building program.

5. Becoming a successful entrepreneur will require a dramatic change in the way you are currently doing things?

6. You will alienate or outgrow many of your current friends and associations; but do not worry you will gain new ones.

7. The monetary rewards will lag your professional achievements by at least “12” months.

8. You must learn to make definite decisions without sufficient information.

9. Calculated risk taking, challenge and discomfort will become a way of life.

10. Your impatience and tolerance will be less for those who ask you the same question twice.

11. Your rate of achievement will increase per your drive and intensity.

12. Your rate of momentum becomes addictive – be careful.

13. You will experience a temporary unbalancing of your personal and professional life.

Your records must be accurate and complete and prepared in a timely fashion. Documentation is the key to proving your tax position. The IRS states in its official publications that you must maintain records that support accurate tax returns. The records should be made at or near the time of the expense when there is accurate recall. Such records must be permanent, accurate, and complete. Failure to meet the adequate documentation standards of the Internal Revenue Code can result in disallowance of your valid deductions. The burden of proof is on you.

There are three types of records that you should maintain. (Note: You want a filing system, not a piling system – no extra charge for that one.)

You will need the following:
1. Permanent files
2. Regular annual files
3. A daily tax diary or log

Permanent files: Includes your prior years’ tax returns, your will, investment purchases and sales, equipment and property purchase records, home purchase records, home improvement records, insurance policies, closing statements, deeds

Regular annual files: Includes sales invoices, vendor bill or receipts, time sheets and payroll records, bank statements, credit card statements

Daily tax diary or log: This may be your appointment book or similar type log. If you don’t maintain a daily tax diary and you get audited by the IRS, be sure to bring your checkbook with you to the audit.

Now what should the daily tax diary or log include? Your daily tax diary or log should include:
• Your appointments
• Where and when you travel, for example out of town travel
• Where you travel by auto – your automobile log in other words
• Where and when your entertain your business contacts, specifically business meal and entertainment expense documentation must include:
The amount of the business expense, date it took place, where it took place, what was the specific business purpose, and the business relationship of the person involved (How much, when, where, why and who)
The basic elements to be proved are: Amount, Time, Place, Purpose and Relationship

Note: A canceled check or credit card charge slip, together with a bill or receipt from the payee, ordinarily establishes the amount of expenditure. However, a cancelled check or charge slip does not by itself support a business expense without other evidence to show that it was for a business purpose. The bill or receipts determines what you actually purchased. A credit card statement alone is not enough proof.

Note: Be very careful in using banks that do not provide proof of cancelled checks.

Sometimes, when I explain this I feel like I am stating the obvious. Heck, I am stating what should be the obvious. But I am convinced most people understand very little about income taxes. Therefore, you must learn to master the timing of your income and deductions. Postponing, deferring, reducing or eliminating taxes is what it is all about, isn’t it?

Generally, most taxpayers who expect to be in the same tax bracket from one year to the next and who want to reduce their current tax bill as much as possible should attempt to defer income to a subsequent year and to accelerate deductions into the current year. (If you suspect you might be in a higher bracket in a subsequent year, you would do just the opposite.) Do not overlook the possibilities!

Question: You are in a 28% tax bracket this year and will be in a 15% tax bracket next year and you need a new computer for your business. When should you buy it?
Answer: The current tax year

I have also seen many cases whereby I try to get my clients to accelerate income and postpone expenses in order to take advantage of the tax brackets.

Big word of warning: Make sure you understand what does “constructive receipt” mean for cash basis taxpayers? You have learned most individuals are on the cash basis of accounting, meaning income is reported for tax purposes when received and expenses are deducted for tax purposes when paid. But, in actuality income must be reported when “constructive” receipt occurs (money is available without restriction).

Example: Via mail you receive a check for the payment of a sales invoice on December 31, 2011, but you don’t deposit it until January 1, 2012 of the following year. Question: When must you report the check as income? Answer: Tax year 2011.

In conclusion, a basic tax strategy for tax planning is to time your income so that it will be taxed at a lower rate and to time your deductible expenses so that may be claimed in years when you are in a higher bracket.

If you ever receive an IRS notice, there is a Notice Number in the right hand corner.  Use this guide to deteremine what the IRS notice means.