April. It’s the time of the year we spend doing our taxes – or, in many cases, using the magic of deductions to try to figure out the best ways to not pay them.
Deductions are essentially costs that you can write off based on expenses from throughout the tax year. There are a lot of business-related tax breaks when you strike out on your own, and the Schedule A and Schedule C forms will become your best friends – they’re where you’ll note all of your expenses.
The IRS is pretty vague about what qualifies, but they define deductible business expenses as an expense that is "both ordinary and necessary." Let’s take a look:
"An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business."
That clearly leaves a lot of wiggle room as to what, exactly, is ordinary and necessary for you to do your job. It’s one thing to be deceptive and write off items you simply don’t want to pay tax for, but it’s another to take a hard look at what you actually do and use to get work done on a daily basis.
As great as it is to owe less tax, it can be daunting, and the fear of an audit – an examination of your return by the IRS to make sure everything is on the up and up – is something most people can’t seem to shake. Two tips for those nervous about paying less:
Hire a professional to help you with your return. Experts will know everything you can (and can’t) deduct and can be a lifesaver if you’re unsure of anything. If you’re doing your own taxes through a software like TurboTax, they may offer accuracy guarantees and provide support in the event that you’re audited.
Save those receipts! If the IRS comes calling, be able to prove every purchase and justify the business cost. Audits aren’t fun. Audits with receipts still aren’t much fun, but they’ll go a little smoother.
So what sort of expenses can you deduct? A lot, as it turns out. Most expenses can be written off as long as they pertain to your business. We’ll run down Schedules A and C and take a look at what can lower your tax bill each year.
Wining and Dining
When you’re running your own business it’s important to get out and meet the people who are paying the bills. The IRS makes this a little easier with write-offs for when you’re out on the town.
A fun tip for this category: the IRS also notes that "you cannot deduct expenses that are lavish or extravagant under the circumstances." Basically: don’t go overboard.
Whether it’s a steak dinner or a cup of joe, when you’re trying to land a client, it doesn’t hurt to suck up a bit by taking him or her out. Business meals can be deducted, usually to the tune of 50% of the cost.
Entertainment also falls under this category. That means you can go beyond meals and take clients to, say, a sporting event. Remember, though, that this isn’t an excuse to get some baseball tickets on the cheap. Be ready to talk shop and close a deal – writing off these expenses means you had "more than a general expectation of getting income or some other specific business benefit at some future time."
Heading somewhere to meet a client or attend a conference? Include the cost of travel and accommodation. Just remember that little note about "lavish or extravagant"; maybe stay away from the Presidential suite.
Your (Digital) Stuff
Think of all of the software and apps you use for work. Evernote? The only way you’re able to keep all of your thoughts in one place regardless of where you are. Dropbox? It’s how you share files with clients. MailChimp? It lets you grow your client base. What about Adobe Creative Cloud or Microsoft Office 365?
The list goes on, but one thing a lot of programs have in common is that they come with paid versions that offer a little more in the way of features, storage space, support, and so on. Free versions might save some money, but why should you settle for good enough? If you’re using these apps for business, the cost of subscriptions can be deducted.
In an interesting note, software can be deducted in two different ways. If you’re purchasing a program, it falls under a Section 179 depreciation deduction. But if you’re paying for a subscription, it can be included as an office expense. These sorts of wrinkles are perfect examples of why you should enlist the services of a tax professional when preparing your tax return.
Your (Physical) Stuff
With no luxurious company cars to take you places, you’ll probably find yourself driving your own car most of the time. You can deduct these costs in one of two ways:
* Actual operating expenses. This includes gas, maintenance, and general repairs. Make sure you keep up with all of these associated costs so you have them ready to total up at the end of the tax year. * [Standard mileage rates.](http://www.irs.gov/Tax-Professionals/Standard-Mileage-Rates) The IRS has made this easy. All you have to do is multiply the business miles driven by 57.5 cents and you’ll end up with your deduction.
If, say, you’re a rideshare driver, the expenses would get added here as opposed to the travel section of Schedule C since you’re on the job when you’re driving and not traveling on a trip.
Note that if you’ve already deducted travel costs in the travel section, don’t also count them here. As in other areas of life, double-dipping is frowned upon in taxes.
We live in a digital world, but a lot of us still have real life physical stuff that will eventually break down. A depreciation deduction is an "allowance for the wear and tear, deterioration, or obsolescence" and lets you recover that cost. Deductions can be made under Section 179, which deducts the entire cost of a purchase, or by depreciating it, deducting a percentage of the cost over the life of the item.
There are some good primers on the difference between these two methods, but it can be confusing to know which you should be using for which items. It’s nice to know that you have options, but let your tax advisor earn his or her pay by making the distinction for you.
The Costs of Doing Business
When you’re a freelancer, you’ll find that the cost of running a business from different services and fees adds up quickly. The good news is there are a lot of miscellaneous payments that you can deduct from your final tax bill – and those add up quickly, too.
Between the challenge of finding consistent work and shouldering the responsibility solo, you’re a pro at handling risk. But unnecessary risk? That’s not what you’re into. And if you’re not insured, that’s exactly what you’re doing: taking an unnecessary risk.
Depending on your profession, you’ll need different types of insurance, whether it’s liability insurance, malpractice insurance, or insurance for your office. What you pay for insurance is nothing compared to what it’ll cost you if you get sued, so it’s already a smart buy. But did you know you can write off the premiums? You’re running out of excuses for not having it.
Keep in mind that this deduction doesn’t cover your (legally-mandated) health insurance. But that’s OK, because…
Health insurance premiums are also deductible. Only the total unreimbursed medical expenses – premiums, prescriptions, exams, and so on – that exceed 10% of your adjusted gross income are eligible, though, so you won’t be writing off everything.
Legal and professional services
Legal advice, tax preparation, business consultations...any service you paid for to help you figure out an aspect of your business, deduct it.
The IRS says that you can deduct any education that "maintains or improves skills needed in your present work" unless you need it to "meet the minimum educational requirements of your present trade or business, or is part of a program of study that will qualify you for a new trade or business."
Essentially it needs to be related to the field you currently have a career in, not something in which you’re just starting out or are planning on transferring to. So if you repair electronics you can take courses in servicing certain new equipment, but that means no underwater basket weaving lessons at the community college for you.
However you get the word out about your business – online banners, business cards, billboards with your face on them – make sure you deduct those costs.
Do you have your own website? It’s the 21st century, of course you do! Costs like domain name purchases and web hosting fees can be deducted.
You can deduct the cost of a helping hand, as long as they were hired as contract labor and not as an employee.
If you did happen to hire an employee – congratulations on your growth! – then that can be deducted later in a different section of the Schedule C form.
If you’ve paid interest on loans, those costs can be deducted. (Business related loans only – student loans don’t count.)
Your Office Away From the Office
You can write off your home office on your taxes, but you have to make sure it’s actually your office. No "I pull my laptop into bed with me and answer emails." No "I cleaned the kids’ breakfast off the kitchen table before I dove into spreadsheets." Your office must 1) be used regularly and exclusively for business, and 2) be your principle place of business.
The amount that’s deductible depends on what your office is actually costing you. And since this office is part of your house, the deduction will be based on what percentage of your home is taken up by your office (as in the actual square footage – you may need to bust out the tape measure). So if the room you’re using as an office is 10% of your total house, you’ll be deducting a tenth of the total costs.
Sound confusing? It is. That’s why the IRS instituted a "simplified" plan in 2013. Essentially, you can deduct $5 per square foot of home office space, up to 300 square feet. For those of you who crunched the numbers, that’s a total possible deduction of $1,500.
This example shows how you could be leaving money on the table with the simplified calculations depending on the costs of your utilities and mortgage. So while one is quicker and easier, the other could net you a larger deduction – and you’ll need to decide which is more valuable to you.
Pretty self-explanatory. Besides the things you keep on your desk – staplers, file folders, pens – this category also includes postage for those of you who still use snail mail.
Internet, electricity, gas, and so on can all be deducted, but it has to be proportional; if these utilities are being shared with the rest of the house, you can only deduct the percentage used by the office itself.
It’s pretty clear that there is a lot to getting your tax breaks; certain things can’t be deducted, others could potentially fall into multiple categories, and there’s a whole lot of math involved.
But it’s completely worthwhile to keep up with your spending and make sure you get everything you’re owed. After all, that money adds up quickly, and what you save in deductions could be the difference between closing up shop and making enough to take your business to the next level. So grab those receipts, call up your tax advisor, and get ready to save.
Image: Steven Depolo