Business Expenses
Ordinary and necessary expenses for your business are generally tax-deductible.
Every business incurs expenses. Even independent contractors, consultants, and freelancers pay for software, computers, or travel out of their own pocket to make their jobs easier. For incorporated businesses, being able to deduct expenses will reduce their business taxes. For sole proprietors, being able to deduct expenses has an even bigger impact: business expenses will reduce both the regular income tax and the self-employment tax. The bottom line? Keeping track of all your business expenses will go a long way to reducing your tax liabilities.
What is a Legitimate Business Expense?
That is a question I hear all the time from clients. There is no hard and fast rule. The basic definition is that an expense must be ordinary and necessary for your trade or profession. That definition comes straight out of the tax law, so do not blame me for being vague. This topic is so huge, the IRS had devoted an entire publication to the topic of business expenses.
Generally speaking, a business expense has a legitimate business purpose. Buying a copy of TurboTax so I can review it for tax related information is a legitimate expense. Even an IRS auditor can see how having a copy of this tax software directly relates to my job. Taking my friends out for dinner, however, is not a business expense. Even though my friends might ask me tax questions or discuss how my business is going, the dinner really is not about closing a deal or negotiating a contract. IRS auditors are on the look out for personal expenses that are masquerading as business expenses.
Problems arise when an expense might be partly personal and partly business related. Common examples I encounter are freelance professionals who have a personal project that turns into a published article. A freelance writer, just to give one example, might be repairing her house, and ends up writing some tips that get published in a magazine. Would her home repair expenses be legitimate business expenses? Or would they be entirely disallowed in an IRS audit? Or is this a middle of the road answer? As a general rule, the IRS will allow you to allocate the expense to personal and business use, and deduct the business portion on your tax return.
So here is a useful tip. Always keep track of all your expenses, even if you have doubts about being able to deduct them. It will be easier for you to ask me about expenses if you keep track of everything.
Keeping Track of Business Expenses
Personally, I use a full-featured accounting software to track my income and expenses. But then again I am a tax professional and feel comfortable using software such as QuickBooks. I highly recommend this program for a small business. Using a full-featured accounting software will help you monitor the health of your company.
QuickBooks software can generate financial statements (called income statements and balance sheets by accountants). These reports help you analyze how your freelance business is doing, whether you are profitable, and how you are spending your money. If you decide to hire a tax professional, having these reports greatly expedites the preparation of your tax returns.
Fully Deductible Business Expenses
Self-employed entrepreneurs incur many common business expenses that are fully deductible against their business income. Find out which business expenses are deductible, and which are partly deductible, for federal tax purposes.
As mentioned, any expense which is ordinary and necessary for your trade or business is deductible under Section 162 of the Internal Revenue Code. Not all expenses, however, are fully deductible.
Here are the most common business expenses that are fully deductible against your business income:
Accounting fees
Advertising
Bank charges
Commissions and sales expenses
Consultation expenses
Continuing professional education
Contract labor
Credit and collection fees
Delivery charges
Dues and subscriptions
Employee benefit programs
Equipment rentals
Factory expenses
Insurance
Interest paid
Internet subscriptions, domain names and hosting
Laundry
Legal fees
Licenses
Maintenance and repairs
Office expenses and supplies
Pension and profit-sharing plans
Postage
Print and copy
Professional development and training
Professional fees
Promotion
Rent
Salaries, wages, and other compensation
Security
Small tools and equipment
Software
Supplies
Taxes
Telephone
Trade discounts
Travel
Utilities
Partial Deductible Business Expenses
Some expenses are only partially deductible:
Gifts: are deductible up to $25 per person. Gift items that cost $4 or less are fully deductible.
Automobile and transportation expenses: must be split between personal use (non-deductible) and business use (deductible).
Home office: must be split between personal use (non-deductible) and business use (deductible).
Meals and entertainment: only 50% is deductible.
Nondeductible Expenses
Some business expenses, even though they may be directly related to your trade or profession, are never tax deductible:
Bribes and kickbacks
Contributions to political parties or candidates
Dues and membership fees for social clubs
Lobbying expenses
Penalties and fines
Ask your tax preparer if you require more information about deductible business expenses.
By Judee Slack EA, CFP, CSA
