Starting a new business is a serious challenge, with many things demanding a new business owner’s attention. There are lots of expenses associated with the start-up and day-to-day operations of a business. Fortunately, many of these expenses are deductible on Schedule C, which lowers the business’s net profit, and therefore the owner’s income tax and self-employment tax.
Deductible expenses are defined in IRS Publication 535, Business Expenses, as those that are “ordinary and necessary.” In this context, “ordinary” means a common and accepted expense for your industry. For example, a mobile computer repair person might legitimately purchase an oscilloscope, but an accountant would not ordinarily do so. “Necessary,” on the other hand, means that the expense is for something helpful and appropriate for the business. It does not mean that it is indispensable.
Many expenses – such as office supplies, bookkeeping, payroll, printer paper and toner, mailing expenses, advertising, insurance, and mileage – are common to most businesses. Although tracking these expenses may seem tedious or cumbersome, doing so will pay off by lowering your tax bite.
Here are five deductions that can benefit small-business owners and self-employed taxpayers.
Tax Deductions for Freelancers & Business Owners
Most forms of advertising expenses are tax-deductible, including flyers, mailers, print ads, and business cards. In addition, table fees or other small-business expenses incurred for the promotion of your business may also be deducted as advertising expenses. Fees that you pay Yelp or Google, for example, for advertising associated with your online presence are also deductible.
2. Website Expenses
If you have a business website, costs associated with creating and maintaining it are also deductible business expenses. Such costs could include fees for hosting, domain name, website design, software, or licensing fees for images used. As long as these are for the exclusive use of the business, they are fully deductible.
Although frequently listed under “Other Expenses,” the business use portion of Internet access fees and router rental are also deductible (see Schedule C, line 27a, and Part V on page 2).
3. Home Office Expenses
If you use some part of your home or property for business use and you use it exclusively and regularly for business, you may be able to take a deduction for expenses related to your home office. The two requirements are that:
- It is your principal place of business
- You use it regularly and exclusively for business
There are two methods to calculate the deduction: the Simplified Method and the Regular Method.
With the Simplified Method, specified in Revenue Procedure 2013-13, you multiply the square footage of the office or business area (not more than 300 sq. ft.) by $5 per square foot to determine the amount of the deduction. The deduction is the smaller of the business net profit and the calculated office deduction.
For example, if your office area is 200 sq. ft., the potential deduction is 200 x $5 = $1,000. However, if your net profit is $800, then the deduction is limited to $800. The unused $200 cannot be carried forward to the next tax year. See Simplified Option for Home Office Deduction for more details.
The benefits of the Simplified Method are:
- Minimal record-keeping, just the square footage of the business-use area
- Other household expenses, such as mortgage interest and property taxes are deductible in full on Schedule A (Itemized Deductions)
- Depreciation is not allowed, so it does not have to be recaptured when the property is sold
The Regular Method is more complicated to calculate but may result in a larger deduction. There are several steps to figuring the office-in-home deduction:
- First, measure the business-use area and divide it by the total square footage of the home. Multiplying the resulting decimal by 100 gives you the percentage of business use. For example, if the office is 200 sq. ft., and the house is 1,600 sq. ft., the percentage is 200/1,600 x 100 = 12.5%.
- Next, determine any direct expenses. These are expenses that apply only to the office, such as the cost of painting the office. There may not be any direct expenses.
- Third, determine the annual expenses for the home. If you own your home, this could include mortgage interest, property taxes, utilities, insurance, repairs and maintenance, and depreciation. If you rent, this could be rent, utilities, and insurance, for example. Unrelated expenses, such as lawn care or painting a room that is not the office, are not indirect expenses and are not deductible.
- Combine the direct and indirect costs for the year.
- Divide the total costs by the total square footage and multiply by the office square footage. Let’s say the total costs were $16,000. Then the deduction is $16,000/1,600 sq. ft. x 200 sq. ft. = $2,000.
The disadvantages to the Regular Method are:
- The calculation is more complicated, and it requires filing an additional form, Form 8829.
- Record retention needs to be detailed and thorough, including tracking depreciation.
- You must recapture the depreciation when you sell the house, even if you did not include depreciation in your calculation of the deduction – the requirement is to recapture depreciation “allowed or allowable.” See Publication 587, Business Use of Your Home, under the heading “Depreciation.”
It is more difficult to calculate and document the Regular Method, but, as you can see from the example, it resulted in a larger deduction than the Simplified Method. The Regular Method requires filing Form 8829 with your return. The Instructions for Form 8829 have more details that may be useful.
A similar limitation on the Office-in-Home deduction applies to the Regular Method as well as the Simplified Method. Namely, your net profit must be greater or equal to the calculated deduction for Office-in-Home. However, with the Regular Method, there is an ordering principle that determines how the business deductions are applied. This ordering is spelled out in Publication 587, Business Use of Your Home, but note that depreciation is applied last.
One last thing: If you itemize deductions, the deductible costs, such as mortgage interest and property taxes, that are not allocated to the business-use percentage are deductible on Schedule A as itemized deductions. In our example, where the business-use percentage was 12.5%, the other 87.5% of mortgage interest and property taxes, for example, would be deductible on Schedule A. See also IRS Home Office Tax Deduction – Rules and
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