Pretty much every American dreads tax season. But when you’re self-employed or a small business owner, filing your income taxes is usually much more complicated — and stressful. You want to make sure you do everything properly to avoid an audit, while also ensuring that you only pay as much in business taxes as is absolutely necessary. After all, you need as much capital as possible to keep your business growing.
Business owners need to understand the differences between itemized deductions and business deductions. All taxpayers must decide whether to use the standard deduction or itemized deduction for personal expenses. Business owners must also track and post business expenses on Schedule C.
This is when tax deductions come in handy. Most people are eligible for the standard deduction on their personal tax return, which is applied to adjusted gross income and lowers your total taxable income. In certain cases, a standard deduction may not get you your maximum tax deduction.
Instead of claiming the standard deduction, it might be best to itemize your deductions. When you itemize deductions, you must list all of your eligible expenses on your tax return. While it takes more work and requires that you keep your receipts throughout the year, in the end, it might allow you to obtain a bigger tax refund or a smaller tax bill.
Here, we’ll review who should itemize their deductions, what forms you’ll need to do so, and the most common deductions you should keep in mind when you file your taxes.
Who should itemize their deductions?
First, you need to make sure that itemizing your deductions is the best route for you — and that you’re eligible to do so. As you can only choose to take the standard deduction or itemize your deductions (not both) you should only choose the itemized deduction route if you think doing so will reduce your tax bill.
That means, the cost of all your deductions should total more than the standard deduction. Here are the standard deduction amounts for the 2018 tax year. If your filing status is single, your itemized deductions must be more than $12,000. If you’re head of household, your itemized deductions would need to be more than $18,000, and if you’re married filing jointly, more than $24,000. If you think your itemized deductions will exceed those numbers, proceed.
If you’re still not sure if itemizing would actually save you money on your taxes, there are a few factors that are strong indicators it would be the smart route for you. For instance, it would likely be in your best interest if:
- You had large out-of-pocket medical or dental expenses
- You paid interest or taxes on your home
- You had large out-of-pocket casualty or theft losses
- You made large charitable contributions
If your itemized deductions are higher than your standard deduction, complete Schedule A and submit it with your personal tax return (Form 1040).
How to account for small business tax deductions
Here are some useful tips to account for your business expenses. First and foremost, you’ll need to keep receipts for all your business-related expenses. Some items you can itemize are fairly specific, and you must have documentation to backup your claims. Instructions regarding business expenses are available on the IRS website under Form 1040 Schedule C, and the forms you’ll need to claim each of these deductions is noted below.
Itemized deductions in detail
Here are the most common itemized deductions, and additional details on how to post these deductions to Schedule A on your personal return.
If you own the home you work in or pay a mortgage on it, there are even more deductions you can take. In fact, you can and should receive a deduction on your mortgage interest.
To do so, your mortgage lender should send you a Form 1098, outlining the deductible interest and points (charges associated with getting a home mortgage) that you’ve paid over the past year. If you’ve refinanced or bought your home in the past year, you may also be able to deduct certain mortgage points that you’ve paid.
You can also deduct personal property taxes — including real estate taxes, and state and local taxes — for the past year. However, if you itemized your deductions last year, you must count any tax refund as income. Note, however, that the Tax Cuts and Jobs Act limits the dollar amount of mortgage interest you can deduct, based on the dollar amount that you’ve borrowed. This limitation on interest deductibility will be in place for several years.
You can deduct the cost of your health insurance premiums from your taxable income if you’re self-employed or own your business. Plus, you can deduct any additional medical costs that you pay out of pocket as an itemized deduction on your personal return.
For instance, if you or a dependent spent money on medical or dental procedures in the past year and those expenses were uninsured, meaning you paid for them out of pocket, they can be entered on your personal return as an itemized deduction. However, in order for these expenses to qualify, they need to add up to approximately 7.5% of your adjusted gross income. These expenses could include things like doctor’s fees, prescription drugs, and inpatient or home care.
In the case of self-employment, if you pay your own healthcare costs, you can deduct all of your health, dental, and long-term care insurance premiums on Schedule C of your tax return. In addition, if you pay for healthcare for your spouse or dependents, those costs are also deductible.
Casualty and theft losses
Casualty and theft losses are now limited to losses that occur due to a federally declared disaster. Refer to the Schedule A instructions to find out more about this personal deduction
What qualifies as a business deduction?
The IRS provides extensive instructions to help you determine what qualifies as a business deduction, and the instructions are helpful for sole proprietors, partnerships and Limited Liability Companies (LLCs). Here’s a look at some common types of business deductions.
Advertising and promotion
As a business person, you know the importance of marketing and advertising. Luckily, any expenses associated with promoting your business’s product or services are typically 100% tax deductible. That means any cash you spend on business cards, signage, or even your website can be deducted from your company’s taxable income — reducing your tax liability.
If your company is run as a sole proprietorship or single-member LLC, you can claim this expense on Form 1040, using Schedule C. On the other hand, if your business is a partnership or multi-member LLC, you can use Form 1065.
Business interest and bank fees
While it’s important to advertise your business, it’s also important to have capital available for business purchases. As such, many small businesses may take out business loans to finance new projects, or use credit cards to buy business-related items — such as office supplies — or to pay for business travel expenses.
In either case, whether you’ve taken out a loan or used a credit card to finance your business, you can deduct the interest incurred on Schedule C. You can also deduct any fees the bank may charge on your business account.
Legal and professional fees
And when it comes to fees, don’t forget that you can also deduct your tax-preparation fees, including any fees associated with tax-prep software or costs to file. This is especially important for self-employed individuals who might prefer to use a professional tax preparer or accounting software to maximize their deductions.
Do you have to meet clients for lunch? Or maybe you need to work from a coffee shop now and again to do some networking? You can deduct that too. In fact, you can deduct up to 50% of any food and beverage costs that were business related on Form 1040, Schedule C. You’ll just need to keep track of the following:
- The amount of each expense
- The date and place of the meal
- The business relationship of the person you dined with
Many small businesses choose to insure their company in order to protect their financial assets and intellectual property from theft. Additionally, most of these policies will help you cover the costs of damage done to your company’s physical assets, including property damage, theft, or vandalism. As insurance is an expense that is often crucial to your company’s continued functionality in case of an emergency, it is also deductible on Schedule C.
Speaking of insurance, if your home is also your place of business you can deduct the cost of your renter’s or homeowner’s insurance as part of your home office deduction. But that’s just the first benefit of working from home.
In fact, if you’re a self-employed independent contractor or own a small business that you run out of your home, the home office deduction is one of the most important deductions you can claim. If you use part of your home exclusively for business use, you can write off the expenses associated with that part of the house (based on the square footage) on your tax return using Form 8829. Then post the deduction amount you calculate to Schedule C. Home office deductions are closely reviewed by the IRS, so you need to have your records in good order.
Business use of your car
If you use your home in the course of operating your business, you might also use your car. If so, good news: That’s another deduction. However, the amount you can deduct will depend on whether you use that vehicle solely for business purposes or use it for both business and personal use.
If the vehicle is used exclusively for your business, you can deduct the entire cost of its operation. That means the cost of any gas, maintenance, car payments and mileage you put on the car can be deducted from your taxable income.
On the other hand, if you use your car for both business and personal purposes, you can only deduct the costs associated with its business use. In general, this means you’ll need to carefully record your mileage and multiply it by the standard mileage rate — it was $0.545 per mile for the 2018 tax year — in order to calculate the total amount you can deduct. (As a note, you can legally use the standard mileage rate, even if your actual mileage costs are less than the rate given by the IRS.)
So the next time you drive to a meeting, trade show, or speaking engagement, be sure to note how many miles you log. Whether you use your vehicle solely for business, or also use it for personal reasons, you can use Form 1040, Schedule C to deduct the costs.
Chances are, as an entrepreneur or self-employed worker, you’re a go-getter that’s always trying to improve yourself and your business. As lifetime learning is one of the best ways to ensure you’re always on top of what’s going on in your industry, it’s good to know that educational costs are also fully deductible — as long as they increase your expertise and add value to your business.
Among the types of educational items that qualify for an IRS deduction are:
- Classes that improve skills specific to your industry
- Workshops that improve your skills and expertise
- Webinars or seminars
- Subscriptions to professional and trade magazines or journals
- Books specific to your field
When it comes time to report these expenses to the IRS, record these costs as professional development on Form 1040, Schedule C.
If you’ve made significant charitable donations in the last year — whether as a business or an individual — those can also be deducted. You can deduct personal charitable contributions on Schedule A of Form 1040.
Use Form 1040, Schedule C to claim business charitable contributions if you own a sole-proprietorship or are self-employed. If you’re filing as an S corporation or a partnership, you will need to file using Schedule K-1. S corporation shareholders and partners in a partnership are issued Schedule K-1, and this form reports income and expenses for the tax year.
Get back to business
If you have questions regarding itemized deductions or business deductions, it’s best to ask a tax accountant or other tax professional. The IRS website is a great resource, but the language on the site can sometimes be a little hard to wade through. The most important part of taking deductions is that you keep your receipts. Doing so ensures that your deductions are as accurate as possible and can protect you in the event of an audit.
Itemizing deductions can lower your personal tax liability, and posting business deductions will decrease your taxes on business income, which can be a big help when it comes time to pay your state and federal taxes. Wading through receipts to find those deductions might not be fun, but it’s definitely worth the time. Paying as little in taxes as possible frees up cash for what you actually want to do: grow your business.