Any home business will have obvious deductions that will be easy to keep track of. Here is a list of some that you may forget about or find troublesome to track. Pay attention to these and reap the tax benefit.
By Jim Conroy, CEO of The Neat Company
When you’re in business, you’ve got to spend money to make money. If you’re in landscaping, you need to buy tools and gas. If you’re designing websites, you’ve got to buy a computer and design software. If you’re a contractor, you need to buy materials and pay labor.
Those expenses are used to help calculate your business profit. Your profit is what the Internal Revenue Service (IRS) will use as the basis for your taxes. It’s simple addition and subtraction: the money you collect less the money you spend on expenses is the profit you’ll be declaring to the IRS. Smaller profit, smaller taxes.
The IRS won’t let you deduct everything you consider an expense. Some expenses are only partly deductible. You may be unable to code without your morning espresso, but you probably won’t be able to deduct the cost of that fancy espresso machine. Exception? If you sell coffee as a line of business. Are you taking a client or potential client to lunch? The IRS will let you deduct 50% of that expense (an expense deduction that will disappear after 2025 per the 2017 Tax Cut and Jobs Act).
You are not obliged to show your documentation to the IRS when you file your taxes. However, the IRS expects you to be able to produce your records if needed (for instance, during an audit).
Basic Tax Deductions
Some deductions are intuitive. If you rent office space, storage space, or fabrication space, those expenses are part of the ordinary cost of doing business, and are deductible. Office equipment (such as your computers, printers, desks, and chairs) and supplies (such as paper and pens) are deductible. Most expenses for a small business or a home business can be found (and documented) in your business checking account. (You do have a business checking account, right?)
Most home businesses are sole proprietorships, with owners filing a personal IRS Form 1040 utilizing Schedule C to describe profit and loss. On its Part II, the IRS lists many deductible expense categories, including:
- Advertising
- Car and truck expenses
- Commissions and fees
- Contract labor
- Depletion
- Depreciation
- Employee benefits programs
- Insurance (other than health)
- Interest
- Mortgage
- Legal and professional services
- Office expense
- Pension and profit-sharing programs
- Rent or lease of vehicles, machinery, and equipment
- Rent or lease of other business property
- Repairs and maintenance
- Supplies
- Taxes and licenses
- Travel
- Meals (at 50%)
- Utilities
- Wages
In Part III, businesses that manufacture goods (for instance, you make jewelry) or sell at retail (for instance, you’ve got an antique shop) can calculate the cost of goods sold through the inventory method of their choice. Vehicle costs are also deductible in Part IV, but the vehicle must be only used for business and not for personal use.
The most relevant question to our discussion is this one: “Do you have evidence to support your deduction?” If you can’t answer that question with a “yes,” you may not even want to try to deduct those costs. But that’s what this is all about.
Specific Things to Track and How to Track Them
According to IRS Publication 535, “To be deductible, a business expense must be both ordinary and necessary.” If you’re a leatherworker, buying a bolt of leather is ordinary and necessary. If you’re a tennis coach, a bolt of leather probably isn’t.
For the most part, there are no legally required methods of keeping records. All the IRS asks is that your records clearly show your income and your expenses. To do so, you may record your transactions in a journal or a ledger. These can be in paper or book form, or they can be electronic, like a spreadsheet. To organize the documents themselves, again, use a system that works best for you — a desk drawer, a file cabinet, or a digital tool. Capturing copies to a cloud drive can be helpful. So can a document management system (DMS) like one offered by The Neat Company. The best of these will capture data from multiple sources, including your smart phone’s camera, emails and attachments, a scanner, or computer files and documents. The DMS will then use optical character recognition to convert all of these into text that can be manipulated, filed, and stored. Often, they can be categorized for later reference or bookkeeping purposes or shared with a tax accountant. The best part is that they are securely backed up on the cloud and available wherever you are.
Therefore, if you’re a contractor, recording your mileage as you drive from job site to lumber yard to building supply warehouse to job site on a log will work for you. You can’t, however, just record all mileage for your pickup if it also goes to the beach with your kids or out to dinner with your spouse.
The Home Office
If you are claiming the use of part of your home as a home office, you will need to determine whether you want to use the simplified method or actual expenses. The simplified method is deducting a flat $5 per square foot for the actual space dedicated to business use only (up to 300 sq. ft). If you’re claiming the actual expenses, direct expenses are deductible in full. If you’re a traveling carpenter and have made the unfinished portion of your basement into a workshop, insurance, utilities, and general repairs for that portion can be deducted. For instance, if your home including your basement is 1,200 square feet and your workshop takes up 300 square feet, one-fourth of those expenses can be deducted. That means you’ll need copies of your utility bills, your heating bills, your home insurance, and any other related bills in your business tax records.
In the End, Efficiency
Financial precision depends on thorough attention to documenting your business activity. Receipts are the backbone of telling your business story. Make reducing clutter and enhancing accessibility your goal whether you choose to store receipts in a file, in a spreadsheet, or in digital form through smart technology. Tax preparation will be cleaner and audits, should they happen, will be survivable. Decision-making will be simpler, too.
