by Tina Perkins
If you are the brave-independent-self-reliant entrepreneur, you have benefits, meaning tax deductions that employees do not have. The upside is tax efficiency which is a code word for lower taxes.
Although one can incorporate their business and get even more tax efficient, this article is directed to the self-employed. Keep in mind that to be a deductible business expense, it must be both ordinary and necessary. An ordinary expense is an expense that is common in your trade/business. A necessary expense is an expense that is helpful and appropriate for your trade/business.
Business expenses by nature exclude personal expenditures and fall into one of three broad categories:
- Cost of goods sold
- Capital expenses
- Operating expenses
COST OF GOODS SOLD
If your business is retail or if you are a manufacturer, these expenditures are the items you sell as a retailer or the labor and raw materials that make up your product as a manufacturer. Beginning and ending inventory values must be determined in either case since the inventory you have on hand at year-end is not deductible.
CAPITAL EXPENSES
These expenditures are not deductible in their entirety in the year you incur the cost; rather, they are capitalized and depreciated over a number of years determined by tax law. These costs generally make up the investment expenditures in your business. They are:
- Business startup costs
- Business assets
- Business improvements
OPERATING EXPENSES
The following is a list of common business expenses.
Advertisement: Must have your business name on ad.
Bartering: This is actually income and is valued at the fair market value of what you received.
Commissions paid: Need to issue a form 1099-Misc if greater than $600.
Depreciation: The annual deductible amount of capital expenditures.
Employees: Hired help is deductible. Additional employment taxes must be paid and quarterly and annual reporting is required. (e.g. 941 and W-2s)
Gifts: Limited to $25/yr. per person.
Home office: Space in the home that is used regularly and exclusively. IRS offers a simplified method for deducting up to 300’sq @ $5/sq.’ (max $1,500/yr.). Establishing a home office is necessary to start the business travel from the home to the first business stop.
Insurance (other than health): Includes professional, auto, liability, and worker’s compensation.
Insurance (health): Includes medical, dental or long-term care insurance premiums that self-employed people pay for themselves.
Interest: Interest you pay on debts related to your trade/business. You must be legally liable for the debt and a true debtor-creditor relationship must exist.
Lodging: Deductible on overnight business travel.
Meals and entertainment: Must be business in nature and is limited, generally to 50 percent. Must have name of person(s) and business purpose.
Office expenditures: Ink, paper supplies, postage, toner, etc.
Owner’s draws: Not deductible.
Phone: The basic cost of your initial land line phone into your home/home-office is considered a non-deductible personal cost. Second lines and other costs (e.g. long distant business calls) are deductible. Cell phones can be problematic since they are generally used for both business and personal. Only the business portion is allowable. This means one needs to determine the percentage of business use and to apply this percentage to the cell phone cost.
Rent: Personal property (e.g. copiers) and real property (e.g. office or warehouse spaces) are deductible.
Repairs and maintenance: Deductible on both personal and real properties.
Retirement (SEP, IRA, Roth): Contributions do lower your income taxes but do not lower your self-employment taxes.
Self-employment taxes: The tax rate is 15.3 percent and is calculated on your net profits. This tax represents the Social Security and Medicare taxes one pays into the social security system.
Training: Must be related to your current trade/business.
Travel (local): One needs to define the tax home. Travel within the tax home between business locations is considered business travel. Travel to and from home and office is a non-deductible personal commute.
Travel (overnight): Outside the general area of one’s tax home, usually longer than an ordinary day’s work and one needs sleep or rest to meet the demands of work.
Utilities: Office electricity, water, heat, and cable are deductible expenses.
Do not commingle your business income and expenses with your personal, this complicates matters. There is more to consider as your business expands and grows.
Organization and communication with a trusted tax advisor are key.
For more information, contact Tina Perkins, Certified Public Accountant, at (228) 392-2991, or at 4048 Popps Ferry Road, D’Iberville, MS 39540. By appointment only.