What tax deductions can the self-employed take? Here are seven types of expenses the self-employed, home businesses, and sole proprietors can deduct.
Are you self-employed? If so, you have to report and pay taxes on your income. So, it’s important to know and take all the tax deductions you’re entitled to. And, as fulfilling and potentially profitable as self-employment is, running a business as a sole proprietor makes preparing your annual tax return a bit more complicated.
The IRS expects you to keep accurate records of your business income and to record and substantiate all your self-employed business deductions.
In fact, finding all of the legal deductions you can take is essential to lowering your tax bill. Don’t lie — don’t even exaggerate. Do make sure that you take advantage of all of the deductions that are available to you. Have you thought of these?
1. The Home Office Deduction
Most small-business owners have heard of this deduction, but it carries a stigma that isn’t true. No longer does it significantly up your chances of an audit. That was true 25 years ago when there were far fewer people working from home, but IRS changes to the home office deduction a few years ago made the deduction more friendly to taxpayers.
There are two tests to pass to claim the deduction: First, the space has to be used exclusively as an office. It can’t be a desk in your den or bedroom. It has to be a room that’s 100% dedicated to your business. Second, it should be your principal place of business. If you have an office away from your home and you use your home office at night or on weekends, you can’t take the deduction.
It’s best to use tax preparation software or get the advice of a tax professional, as this deduction can get complicated, but don’t avoid it for fear of an audit.
Read more about the home office deduction.
2. Deductible Vehicle Expenses
Again, you may know that a business vehicle is deductible, but if you think that you can only deduct expenses from a vehicle that’s used 100% for business purposes, think again. This is not your home office. Vehicles are different. There are two methods to deduct vehicle expenses: the standard mileage rate or your actual expenses. Think of it as being similar to itemizing or taking the standard deduction on your personal taxes.
The standard mileage rate is the easiest way. Add up the miles you drove for business and multiply by the rate for that year. To use your actual expenses instead of the standard mileage rate, you can add up all of your expenses including gas, repairs and maintenance, insurance, registration, and anything else and then subtract from the total the percentage you used your vehicle for personal use.
You will need documentation either way, but if your record-keeping skills could use a little improvement, you should probably stay with the standard mileage rate.
Tip: Don’t forget to save receipts from toll booths and parking lots. No matter which method you use, you can deduct tolls and parking fees you incur during business travel as a separate item from car expenses.
3. Deduct your necessary business expenses
The IRS refers to these as “ordinary and necessary” expenses. Besides the mundane supplies like staples and paper that you use every day, depending on the nature of your business, your necessary business expenses might include skis, a toolbox, kitty litter, or an Internet marketing conference in Las Vegas. The two keys to making unusual business deductions stick:
- Keep receipts.
- Keep good records showing the reason for the expense and how it was used in or helped your business.
4. Bad Debt Tax Deductions
Do you have customers on your books who haven’t paid? Providing you include the revenue in your gross receipts, you can deduct the bad debt. If you use the accrual method for your accounting, you’re claiming the income as you bill it so you could take a bad debt deduction.
If you use the cash method, you’re not claiming the income until you have the money in hand. In that case, you can’t deduct bad debt because it’s not on your books as income.
Related: Tax-Deductible Startup Expenses
5. Work Opportunity Tax Credits
If you hired an employee in a certain target group as defined by the Department of Labor, you can receive a tax credit of up to $9,600 depending on the type of employee hired. Eligible employees include some veterans, people receiving food stamps, and some ex-offenders, among others. Go to the Department of Labor’s website and to the IRS page that explains the Work Opportunity Tax Credit to learn more.
6. Insurance and Retirement Tax Deductions
If you’re paying for health insurance premiums and you’re not eligible under a spouse’s plan, those costs are 100% deductible. If your spouse is working for you and you offer the same benefits to other employees, you can deduct his or her costs, as well. You can’t deduct more than the net income of your business.
You can also deduct the amount you contributed to a qualified retirement plan. Do this on your personal taxes since it affects you as an individual.
RELATED: How to File a Tax Extension
7. Social Security
This is one of the downsides of being a small-business owner. Not only do you have to pay your own Social Security premium, but businesses are also required to pay half of your premium on your behalf. As a result, you have to pay both halves.
You can deduct, however, half of what you paid on your 1040 return.
Finally…
As your business grows, you’ll find a level of complexity to tax law that you didn’t think possible. That’s why you’ll probably want to hire a tax professional to help. It might not be this year, but if you do your own taxes, you may be leaving deductions unclaimed. If so, a tax professional may be money well spent. (And the money you pay that person is deductible, too.)
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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