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While tax law is complicated, the benefit of utilizing tax deductions is simple. The more legitimate deductions you’re able to claim, the less tax you pay. As a sole proprietor, using a majority of their business earnings as income, these are some of the small business deductions you should know:
Many sole proprietors mistakenly fear that claiming the business use of their home will instantly result in an audit. While this has been proven to be untrue, in order to claim the home office deduction you need to ensure, that:
Note: Your home office does not have to be your primary place of business. For instance, if you have a storefront but do most of the administrative tasks at home, you may still claim a home office deduction.
The Internal Revenue Service (IRS) allows two methods for filing a home office deduction:
The best way to know which method to choose is to do a rough calculation of each. If the simplified method is close to what you’d get with the standard method, then you can save yourself some work and use the simplified method. Note: Once you choose a method and submit your return, you can not go back and change methods.
If you run a licensed daycare from your home, the calculations for the standard method get a little more complex by factoring square footage of a room/space used with the percentage of time it’s used for your business.
As a business owner you can deduct the actual expenses incurred on travel and mileage for business. Travel expenses may include airfare, hotel, rental cars, meals, etc. (Note: If you bring your family with you, their expenses are only covered if they were also working for the company during the trip.) If your vehicle is used exclusively for business, you may claim the full amount of expenses, like parking, gas, tolls, and repairs. If the vehicle is used for business and personal use, then the portion of expenses related to business use only can be claimed.
As the home office deduction, you may use the standard or simplified method to claim vehicle expenses:
If you are having a meal, coffee, or cocktail as part of a business meeting, entertaining a client, or any other business function, you may claim 50% of the costs. But don’t get too crazy. Lavish or overly expensive claims are not allowed.
While you may know that you have to pay social security and medicare taxes, you may not be aware that you can actually claim some or all, of these costs on your return.
If you are in the first year of establishing your business, you may claim up to $5,000 in startup costs, such as legal, advertising, and consulting fees, without having to capitalize the expenses across several years. Note: If your startup costs are $50,000 or more the deduction starts to decrease and if your total is $55,000 the deduction is taken away.
As a stimulus act, Section 179 Depreciation, gives small businesses the opportunity to claim up to $500,000 in qualified equipment purchases, including software, within the purchase year — without having to allow for capitalization. Claiming Section 179 Depreciation requires the use of Form 4562. However, the benefits often outweigh the burden of one more piece of paperwork.
A key advantage of being a sole proprietorship is having the ability to claim a health insurance deduction for yourself, your spouse, and/or your dependents. This deduction is limited to your taxable income and can only be claimed for the months that you, your spouse and/or your dependents are not covered by any group insurance through an employer.
Sometimes money may seem like it’s gone when it really isn’t. If you can prove that an unpaid invoice was uncollectable, you can write off the full amount of bad debt (if you are using the accrual method of accounting). Even the cost of doing business can be written off by deducting interest on business-related loans along with checking account, ATM, and other banking fees.
There are lists and lists of deductions out there, for instance, American Express has a list of the 10 Most Overlooked Small Business Tax Deductions, Lifehack has the Top 10 Tax Write-Offs for Small Business Owners and Wagepoint offers the Comprehensive List of Small Business Tax Deductions. To find more, simply enter the search terms “small business tax deductions.” (Be sure to consider the source and check the date of publication. The more recent the date, the more accurate the information is likely to be.)
Planning for tax season shouldn’t start as the deadline approaches, it should actually be a part of the way you do business all year. A few of the basic principles include: