Just about any "ordinary, necessary, and reasonable" expense that helps you earn business income is deductible. What's ordinary and necessary? The IRS has defined this as anything that's "helpful and appropriate" for your business. For example, buying a computer, or even a sound system, for your office or store can be an ordinary and necessary business expense. Buying the same items for your family room cannot be a business expense, however.

A few things are specifically prohibited by law from being deducted even if the expenses are for the purpose of conducting business -- for instance, a bribe paid to a public official. Other deduction no-nos are traffic tickets, your home telephone line, and clothing you wear on the job, unless it is a required uniform. For more information, see Small Business Tax Deductions.

You can calculate your vehicle deduction using the standard mileage method or the actual expense method. The standard mileage method is more commonly used because the record-keeping requirements are much simpler. Under this method, the IRS determines the amount you can deduct per mile. Effective January 1, 2009, the rate is 55 cents per business mile driven. In 2008, the IRS increased the rate half-way through the year because of the high cost of fuel. The rate was 58.5 cents per mile for July 1, 2008 through December 31, 2008 and 50.5 cents per mile for January 1, 2008 through June 30, 2008.

Under the actual expense method, you deduct the actual costs you incur each year to operate your car, plus depreciation you pay for gas and repairs (according to a tax code schedule). Your deductible costs include gas and oil, repairs and maintenance, license fees, insurance, tolls, and even car washing. If you use the car partly for personal use, you must multiply your actual expenses by your percentage of business use.

Most people use the standard mileage rate because they don't want to bother with a lot of record keeping. But this ease comes at a price -- you usually get a lower deduction using the standard mileage rate than you would with the actual expense method. You must use the standard mileage rate, however, if you claimed certain related deductions (such as under Section 179 of the IRC) in previous years. (For more information on Section 179 depreciation, see Small Business Tax Deductions.)

To use either of these methods, you must keep track of how much you use your car for business. (And you'll need to produce your records if you are audited.) Keep a log showing the miles for each business use, always noting the purpose of trip.

You can also depreciate (write off) the cost of the vehicle over a number of years. For more information, see Deduct It!: Lower Your Small Business Taxes, by Stephen Fishman (Nolo).

You may deduct only 50% of expenses for entertaining clients or customers for business purposes, no matter how many martinis or Perriers you swigged. (Yes, this is a change. In the old days you could write off 100% of every entertainment expense, and, until a few years ago, 80%.) Qualified business entertainment includes taking a client to a ball game, a concert, or dinner at a fancy restaurant, or just inviting a few of your customers over for a Sunday barbecue at your home.

Keep in mind that if you are audited, you must be able to show some proof that the entertainment expense was either directly related to, or associated with, business. So, keep a guest list and note the business (or potential) relationship of each person entertained.

Parties, picnics, and other social events that you put on for your employees and their families are an exception to the 50% rule -- such events are 100% deductible, and you need not prove it was directly related to a business goal.

Current expenses can be deducted from your business's total income in the year you incur them. They include the everyday costs of keeping your business going, such as office supplies, rent, and electricity.

Expenditures for things that will help generate revenue in future years -- a desk, a copier, or a car, for example -- are called capital expenses and must be written off over their useful life. Usually that period is three, five, or seven years, according to IRS rules. (See Current vs. Capital Expenses for more information.)

There is one important exception to this rule, called the Section 179 deduction, which may let you fully deduct capital expenses in the year you incur them. For more information on Section 179 of the IRC, see below, If I buy a new computer system this year, do I have to deduct the cost over a five-year period? There is also a bonus depreciation for property placed in service in 2009 and 2008. This special deduction for those two years allows taxpayers to depreciate 50% of the adjusted basis of qualified property during the first year the property is placed in service. 

Probably not. Under Section 179, you can deduct in one year the cost of tangible personal property that you buy for your business (such as computers, office furniture, and equipment). This is a major exception to the general rule that the cost of capital equipment -- equipment that has a useful life of more than one year, such as a computer system -- must be deducted over a number of years.

There is a limit to the total amount of business property expenses that you can deduct each year under Section 179. For 2009, the limit is $250,000, subject to a phase-out if you purchase more than $800,000 of equipment in one year. Many small businesses can fit all of their capital expenditures each year into this allotted amount. For 2010 and later, the limit is scheduled to be much lower ($133,000 plus an annual inflation adjustment with a $510,000 phase-out cap).

Section 179 doesn't apply to land, buildings, inventory, intangible assets, and air conditioning and heating units. It does apply to vehicles, but special rules limit the portion of the cost of a car that you can depreciate each year.

There is also a special bonus depreciation deduction for property placed in service in 2009. Under this provision, taxpayers can depreciate 50% of the adjusted basis of qualified property during the first year the property is in service. For more information, see Deduct It!: Lower Your Small Business Taxes, by Stephen Fishman (Nolo).

If you take others with you on a business trip, you can deduct business expenses for the trip, but no more than if you were traveling alone. If, for example, your family rides in the back seat of the car and stays in one standard motel room, then you can fully deduct your automobile and hotel expenses. But you can't claim a deduction for your family's meals or jaunts to Disneyland or Universal Studios.

If you extend your stay and partake in some of the fun after the business is over, the expenses attributed to the nonbusiness days aren't deductible, unless you extended your stay to get discounted airfare (the "Saturday overnight" requirement). In this case, your hotel room and meals would be fully deductible.

Also, you can fully deduct the cost of your airline ticket even if it features a two-for-one or companion discount.

If you run a business out of your home, you may be able to take the home office deduction. This allows you to deduct a portion of your rent or mortgage costs, as well as some related costs -- such as utilities, insurance, and remodeling. However, there are strict requirements you must meet. For instance, you will not qualify if you use your office partly for work and partly for personal reasons, or if you don't use the space regularly for business.

For more information, see The Home Office Tax Deduction or check with a tax professional.

Start by learning a new set of "3 Rs": record keeping, record keeping, and (you guessed it) record keeping. IRS studies show that poor records -- not dishonesty -- cause most small business owners to fail to comply with their tax reporting obligations and to lose at audits, with resulting fines and penalties.

Even if you hire someone to keep your records, you need to know how to supervise him or her -- because if your bookkeeper goofs up, you are responsible. Consider using a computer to keep your records if you aren't already in the electronic age.

Keep all receipts and canceled checks for business expenses, and keep them organized and in a safe place. Separate the documents by category, such as:

• auto expenses
• rent
• utilities
• advertising
• travel
• entertainment, and
• professional fees.

Put your documents into individual folders or envelopes. If you are ever audited (and small businesses are about three times more likely to be audited than individuals), the IRS is most likely to zero in on business deductions for car expenses and travel and entertainment expenses. Furthermore, the burden will be on you -- not the IRS -- to substantiate your deductions. 

Keep in mind that most corporate tax benefits flow to profitable, established corporations, not to start-ups in their first few years. For example, corporations can offer more tax-flexible pension plans than sole proprietors or partnerships, but few start-ups have the cash flow needed to take advantage of these tax breaks.

Similarly, the ability to split income between a corporation and its owners -- thereby keeping some income in lower corporate tax brackets -- is effective only if the business is solidly profitable. >

In addition, incorporating adds state fees, as well as legal and accounting charges. So unless you are sure that substantial profits will begin to roll in immediately, you may want to hold off incorporating your business.

To keep your own books, consider using a check-register type computer program such as Quicken Home & Business or Quickbooks (by Intuit) to track your expenses. If you are doing your own tax return, use the companion program, TurboTax.

To make sure you're on the right track, it's a good idea to run your bookkeeping system by a savvy, small business tax pro. With just a few hours of work, he or she should help you avoid most common mistakes and show you how to dovetail your bookkeeping system with tax filing requirements.

When your business is firmly in the black, consider hiring a bookkeeper to take care of your day-to-day payables and receivables, and an outside tax pro to handle your heavier-duty tax work. Not only are a tax pro's fees a tax-deductible business expense, but chances are your business will benefit if you put more of your time into running it and less into completing routine paperwork.