Everything You Need to Know About Deducting Expenses When You’re Self-Employed
Becoming self-employed and working from home in many ways epitomizes the American dream. You are your own boss, instead of putting on a penguin suit every morning you get to stay in your pajamas, and there is never a line at the office coffee machine when you need a cup. But the dream of self-employment is not without its complications, especially when it comes to figuring out your taxes and deductibles. If you’re self-employed and starting to freak out about doing your own taxes, take a few deep breaths. The W Tax Group’s seasoned staff of tax attorneys is here to guide you through the arduous task of preparing your taxes and properly deducting what you rightfully should.
Becoming self-employed and working from home in many ways epitomizes the American dream. You are your own boss, instead of putting on a penguin suit every morning you get to stay in your pajamas, and there is never a line at the office coffee machine when you need a cup. But the dream of self-employment is not without its complications, especially when it comes to figuring out your taxes and deductibles. If you’re self-employed and starting to freak out about doing your own taxes, take a few deep breaths. The W Tax Group’s seasoned staff of tax attorneys is here to guide you through the arduous task of preparing your taxes and properly deducting what you rightfully should. We’ve put together a guide of easy ways that you can deduct expenses from your self-employment earnings to lighten your tax load. So keep your pajamas on, go get another cup of coffee, and keep reading for tips and tricks on what you can deduct and how you can do it.
So, What Exactly Am I Allowed to Deduct?
You can’t just go around deducting everything under the sun. Lattes and vacations to Aruba are not deductible, no matter how much you try to convince yourself and others it was all for business. What is deductible though are business expenses that are both ordinary and necessary.
Now what in the world makes something both ordinary and necessary? Well, according to the IRS an ordinary expense is one that is common and accepted in your trade or business. That means unless you own a sushi restaurant, listing the take out sushi you order every weekend as a business expense isn’t going to fly.
A necessary expense is something that is helpful and appropriate for your trade or business. This doesn’t mean that the expense needs to be indispensable for it to be necessary.
Here’s where it gets tricky. There are business expenses, and then there are three other type of expense that often get confused with business expenses because they’re related. Don’t get these things mixed up, because they involve different filing forms and procedures.
- Expenses related to the cost of selling goods
- Capital expenses
- Personal expenses
Cost of Selling Goods
If you’re business doesn’t sell goods, then you can skip this section and move on. But if you do, you’re going to need to read this to learn about deductibles involved in goods related expenses.
If you’re a business that makes things or purchases them for resale, then you probably already know that you need to value inventory at the beginning and end of each tax year to determine the cost of goods sold. Some expenses may include figuring out the cost of goods sold. The cost of goods sold is deducted from your gross receipts to figure your gross profit for the year. If you can include an expense in the cost of goods sold, you cannot deduct it again as a business expense.
We know that was a lot of mumble jumble that you may or may not have understood. So, let’s break it down for you. Basically if you include any of these costs as an expense in the cost of goods sold, then you can’t go back and deduct it again as a business expense. That’s really all there is to it. No double dipping, or in this case, no double deducting.
- The cost of products or raw materials, including freight
- Direct labor costs (including contributions to pensions or annuity plans) for workers who produce the products
- Factory overhead
Capital Expenses-What They Are and What To Do With Them
The second type of expenses that are separate from business expense are capital expenses. Sometimes you just have to capitalize instead of deducting some costs. These costs then become part of your investment in business and are called capital expenses. The good news is that capital expenses are considered assets in your business. The three types of costs that you can capitalize include:
- Business start-up costs
- Business assets
How Do I Tell the Difference Between Personal and Business Expenses?
This one can get tricky. A lot of people blur the line between personal and business expenses, but we’re here to clear all that up. Some questions people often ask us are what if I have an expense that I use partly for business and partly for personal purposes? Well, the answer here is so obvious that it can be easy to miss. All you have to do in this situation is divide the total cost of the expense into two parts: business and personal. Then you can deduct the business half.
Other things are not so obvious. You cannot deduct living or family expenses as business ones. You cannot deduct borrowed money that you used for personal purposes like a family vacation, a new car, etc. You can however deduct expenses that seem like they should be personal if you are, in fact, using them for business.
Using Your Home & Car For Business
Many self-employed people use part of their home or car for business purposes. The good news is that you get to deduct those expenses. The expenses that you can deduct include things like:
- Mortgage interest
All of these expenses related to your home and car are perfectly acceptable to deduct as long as you are using the space and vehicle for business. It’s possible to use your home and car for both business and personal purposes, just make sure that you divide up the square footage and the mileage that you are using solely for business and deduct that.
This is Great! What Else Can I Deduct?
Hold your horses there eager taxpayer. Deducting is great, who doesn’t love saving money? But you have to be careful with the expenses you deduct as a self-employed taxpayer. If you go overboard and start deducting every mile you drive or every fancy dinner you go to as business expenses, the IRS will suspect you of fraud. Here are some other expenses that it’s possible to deduct:
- Employees’ Pay – You can generally deduct the pay you give your employees for the work they do for your business.
- Retirement Plans – You and your employees’ retirement plans are both deductible.
- Rent Expense – In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business.
- Interest – Business interest expense is an amount charged for the use of money you borrowed for business activities.
- Taxes – You can deduct various federal, state, local, and foreign taxes directly attributable to your trade or business as business expenses.
- Insurance – Generally, you can deduct the ordinary and necessary cost of insurance as a business expense, if it is for your trade, business, or profession.
There you have it, those are just a few easy ways that you can deduct expenses when you’re self-employed. Make sure that you keep track of all your spendings and differentiate between business, personal, capital expenses, and the expenses related to the costs of selling goods.
If you have any questions about what you can or cannot deduct as a self-employed taxpayer, get in contact with a tax attorney to avoid any tax controversy with the IRS. Here at The W Tax Group, we help a lot self-employed clients with their deductibles and can help you too! Give us a call or send us an email so we can find the perfect tax resolution for you.
Lead Tax Attorney, The W Tax Group