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Are you self-employed? If so, you've achieved a goal millions only dream about. But as fulfilling and potentially profitable as self-employment is, running a business as a sole proprietor makes preparing your annual tax return a bit more complicated. You're responsible both for reporting all of your business income, and for keeping track of and substantiating all your self-employed business deductions.
If you had a banner year last year, first, congratulations and second, finding all of the legal deductions you can take is essential to lowering your tax bill. Don’t lie - don't even exaggerate. Do make sure that you take advantage of all of the deductions that are available to you. Have you thought of these?
1. Home Office
Most small-business owners have heard of this deduction, but it carries a stigma that is not true. No longer does it significantly up your chances of an audit. That was true 25 years ago when there were far less people working from home but the IRS recently made changes that made the deduction more taxpayer friendly.
There are two tests to pass to claim the deduction: First, the space has to be used exclusively as an office. It cannot be a desk in your den or bedroom. It has to be a room 100 percent dedicated to your business. Second, it should be your principal place of business. If you have an office away from your home and you use your home office at night or on weekends, you cannot take the deduction.
It’s best to use tax preparation software or get the advice of a tax professional as this deduction can get complicated, but don’t avoid it for fear of an audit.
2. Your Vehicle
Again, you may know that a business vehicle is deductible, but if you think that you can only deduct expenses from a vehicle that is used 100 percent for business purposes, think again. This is not your home office. Vehicles are different. There are two methods to deduct vehicle expenses: the standard mileage rate or your actual expenses. Think of it like itemizing or taking the standard deduction on your personal taxes.
The standard mileage rate, which is 54 cents for 2016, is the easiest way. Add up the miles you drove for business and multiply by the rate. To use your actual expenses instead of the standard mileage rate, you can add up all of your expenses including gas, repairs and maintenance, insurance, registration, and anything else and subtract from the total the percentage you used your vehicle for personal use.
You will need documentation either way, but if your record keeping skills could use a little improvement, you should probably stay with the standard mileage rate.
Tip: Don't forget to save receipts from toll booths and parking lots. No matter which method you use, you can deduct tolls and parking fees you incur during business travel as a separate item from car expenses.
3. Your Necessary Business Expenses.
The IRS refers to these as "ordinary and necessary" expenses. Besides the mundane supplies like staples and paper that you use every day, depending on the nature of your business, your necessary business expenses might include skis, a toolbox, kitty litter or an Internet marketing conference in Las Vegas, NV. The two keys to making unusual business deductions stick:
- Keep receipts
- Keep good records showing the reason for the expense and how it was used in or helped your business.
4. Bad Debt
Do you have customers on your books that have not paid? Providing you included the revenue in your gross receipts, you can deduct the bad debt. If you use the accrual method for your accounting, you are claiming the income as you bill it so you could take a bad debt deduction.
If you use the cash method, you are not claiming the income until you have the money in hand. In that case, you cannot deduct bad debt since it is not on your books as income.
5. Work Opportunity Tax Credits
If you hired an employee in a certain target group as defined by the Department of Labor, you can receive a tax credit of up to $9,600 depending on the type of employee hired. Eligible employees include some veterans, people receiving food stamps, and some ex-offenders among others. Go to the Department of Labor’s website and to the IRS page that explains the Work Opportunity Tax Credit to learn more.
6. Insurance and Retirement
If you are paying for health insurance premiums and you are not eligible under a spouse’s plan, those costs are 100 percent deductible. If your spouse is working for you and you offer the same benefits to other employees, you can deduct his or her costs as well. You can’t deduct more than the net income of your business.
You can also deduct the amount you contributed to a qualified retirement plan. Do this on your personal taxes since it affects you, the individual.
7. Social Security
This is one of the downsides of being a small-business owner. Not only do you have to pay your own Social Security premium, businesses are required to pay half of your premium on your behalf. As a result, you have to pay both halves.
You can deduct, however, half of what you paid on your 1040 return.
As your business grows, you’ll find a level of complexity to tax law that you did not think possible. At some point, it will be best to hire a tax professional to help. It might not be this year, but if you do your own taxes, you may be leaving deductions unclaimed. If so, a tax professional may be money well spent. (And the money you pay that person is deductible too.)
Related: Tax deductible startup expenses
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