All of your expenses that weren't part of cost of goods sold are then listed, and the total of these is subtracted from your gross profit to come up with your net operating profit or loss.

For home-based businesses, some of these expenses are frequently questioned by tax offices, because the place of business and various assets used in the business are often used for personal as well as business purposes. When you use your home for the business, you're also using the home's heat, electricity, and perhaps telephone expenses for the business too. The same goes for your vehicle.

Whenever you're determining your business expenses, the key is to be reasonable. Stopping for a gallon of milk on your way home from a business appointment might not be an issue — the bulk of your mileage was still used for business purposes.

But if you try to write off the family's trip to Walt Disney World on the premise that you stopped in to see a client while you were there, you're on extremely shaky ground. Similarly, while the cost of subscribing to a trade publication might well be a reasonable deduction; your subscription to a television listings magazine probably isn't (unless, of course, you can prove that it's a necessary part of your employment as a television reviewer!).

Business-Use-of-Home Deductions

Most home-based businesses will qualify to take the deductions for business use of the home if they meet the key requirements:

• The space is used exclusively and regularly for the business.

• The home is the principal place of business.

• The home is where you meet or deal with customers or clients in the normal course of business.

You can use two different formulas to determine the percentage of your home that's used for the business. One is the area method: Divide the area of your home used for business by the total area of your home. If, for example, your office is 100 square feet of a 1,000-square-foot home, your office is 10 percent of your home.

The other method uses the number of rooms, and applies in particular if your rooms are all about the same size. If the house has ten rooms, and you use one of them as your office, again, you're using 10 percent of your home for the business.

You then multiply your home expenses, such as utilities, insurance, maintenance, property tax, and mortgage interest or rent by your business-use-of home percentage to figure out what you can claim. Note that your ability to deduct business-use-of-home expenses is limited in some cases: In general you can't create or increase a net loss by deducting business-use-of-home expenses. You may, however, be able to carry forward the expense into a year when you do produce a net profit.

In the United States, you'll use “Expenses for Business Use of Your Home” (Form 8829) to figure out the deduction. Publication 587, Business Use of Your Home, contains more information. In Canada, check the Business and Professional Income (T4002) guide.

Vehicle Expenses

In the United States, you have a choice between claiming actual vehicle expenses or the standard mileage deduction (44.5 cents per mile for 2006 and generally updated annually in the fall for the year ahead). In Canada, you claim actual vehicle expenses.

Actual vehicle expenses include gas and oil, insurance, lease payments, interest payments on loans, licenses, repairs, depreciation, and registration. Once you've calculated your total actual expenses, you multiply that figure by the percentage you used the vehicle for business to come up with the amount that you can actually deduct.

Gifts, Meals, and Entertainment

In the United States, you can claim a maximum of $25 for each gift that you give to clients or potential clients, even if the gift exceeded that cost.

Meals and entertainment are generally claimed at a maximum of 50 percent of the allowed expense. For details, check IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses.

In Canada, check with either the CRA or your accountant to see if gifts qualify as expenses for your situation. Meals and entertainment also come with a 50-percent limit and are explained in CRA Interpretation Bulletin IT 518, Food, Beverages, and Entertainment Expenses.

Depreciation

Some business assets lose value over time. Computers and vehicles are common examples, but any machinery or other property that generally lasts more than a year will depreciate rather than be directly expensed. Inventory for resale is not depreciable, but copyrights and patents are.

In general, you deduct depreciation over the life of the asset; however, there are some assets, such as computers, that can be depreciated more quickly, and sometimes even expensed in the year of purchase (which can be an advantage if you had a good revenue year). See IRS Publication 946, How to Depreciate Property and the CRA's Business and Professional Income (T4200) guide for more details.

Start-up Expenses

You may be able to claim your start-up expenses for the business — that is, the expenses you incurred prior to actually opening your doors to clients or customers. However, this can be a tricky area, so it's best to check your regulations to make sure that you declare the most appropriate date for your business's start. IRS Publication 535, Business Expenses, can help. In Canada, check CRA Interpretation Bulletin IT-364, Commencement of Business Operations.