It’s no secret that starting your own business can be lucrative, but there are some caveats you need to consider before jumping in with both feet. Deducting business expenses can help you reduce the amount of taxes you pay on your personal income, but only if you understand which expenses are allowed under the law and which ones aren’t. This article will help guide you through the basics of deducting business expenses on your taxes so that you don’t run into trouble with the IRS in the future.
What Are Business Expenses?
Before we get into a discussion about whether business expenses are tax-deductible, it’s important to distinguish between two common types of expenses: personal and business. According to IRS Publication 535 (Taxable and Nontaxable Income), there are two basic types of expenses that you can incur during your business operations:
Ordinary – Common and accepted expenses in your trade or business. For example, the cost of goods sold for a retailer.
Necessary – Expenses that are appropriate for your trade or business. These help you run your business more efficiently. For instance, the cost of a computer for an accountant.
Generally, expenses that are ordinary and necessary for your business are deductible. The key is being able to show how the expense was essential for your business operations if challenged by the IRS.
What Can I Deduct?
The IRS regulates business expenses in order to ensure that taxpayers are able to deduct only those expenses that are for their trade or business. However, there is no definition of what trade or business is. The IRS has said that every taxpayer must be able to answer two questions:
1) Whether an activity qualifies as a trade or business
2) Whether an activity qualifies as his/her own trade or business
If you can show that the expense was both ordinary and necessary for your particular business, it should qualify as a valid deduction. Some common examples include:
- Office supplies and expenses
- Equipment and machinery
- Software and tech tools
- Travel and transportation
- Meals and entertainment (subject to limits)
- Advertising and marketing
- Interest paid on business loans
- Accounting and legal fees
How Do I Calculate My Tax Deductions?
Tax deductions are simply expenses that have been used up in your business that can legally be subtracted from your total revenue and income during tax season. The most common types of tax deductions include office supplies, meals eaten while working, mileage driven for business, equipment purchases, and much more.
Take a look at IRS Publication 535 for a comprehensive list of tax deductions you might qualify for as a small business owner or self-employed individual. The key calculations are:
- Add up all your business income sources
- Add up all your qualified business expense deductions
- Subtract your deductions from your income to find your taxable income
Just make sure you maintain thorough records and receipts for all expenses in case of an audit. Proper documentation is key.
Can My Employer Help Me Out?
Some employers offer reimbursement for business expenses, but not all of them do. If your employer doesn’t reimburse you for business expenses, that doesn’t mean you can’t deduct those costs from your taxes.
In fact, if you have a job and you spend money in order to do it – money that isn’t reimbursed by your employer – you can claim those expenses as deductions when filing your tax return. For example, a teacher who buys classroom supplies for students or a delivery driver who pays for gas and maintenance on their own vehicle.
Record keeping is a big part of being a business owner. From expenditures like supplies and clothing to travel and entertainment, it’s important that you know exactly what you’re spending and can justify your expenses if necessary.
It may be wise to invest in a small notebook or binder in which you can keep receipts for every single thing that could be construed as a business expense. Organize them by category and date. Digitizing your records can also help with storage and retrieval. The key is being able to access documentation quickly if you get audited.
Examples of Commonly Claimed Items
Make sure you have all your receipts and records so you can write down every one of your business expenses. Your organization, office supplies, travel, computers, and Internet connection are just a few things that could be eligible for a deduction. If you’re worried about getting everything organized in time for tax season, review these commonly claimed items that might help simplify things when it comes time to file:
- Office rent and utilities
- Office furniture and equipment
- Business insurance plans
- Shipping and postage
- Business travel expenses
- Phone, internet, and tech costs
- Advertising and marketing
- Continuing education and training
- Professional services like accountants
- Business bank fees and loan interest
Keeping Good Records
The key to deducting business expenses is maintaining good records. This means keeping receipts and documenting purchases, mileage, supplies, and everything else you spend money on related to your business.
Most record-keeping software makes it easy for you to store these files online in a way that will help you if an IRS agent or other auditor comes knocking. Just remember that the burden of proof is on you to justify that an expense qualifies as an ordinary and necessary business deduction. Proper documentation is your protection.
With some diligent organization and record-keeping, deducting business expenses can help reduce your overall tax burden as an entrepreneur or small business owner. Just make sure you understand the deduction rules and maintain thorough support in case of an audit. If you have questions, don’t hesitate to consult with a tax professional.