Tax deductions can save your small business a significant chunk of change at the end of the year. And one of the best ways to tax deductions is to itemize your expenses. Never itemized expenses before? Not to worry. We’ll cover everything you need to know to itemize expenses for a sole proprietorship. First, though—how is itemizing different from other types of deductions?
What are itemized deductions?
When you choose to file itemized deductions, you list all of your deductible expenses for the year, and their amounts. The total is subtracted from your income for the year, and the result is your tax burden—the amount you’ll be taxed. If you don’t itemize your deductions, you can opt for a standard deduction.
Itemized deductions vs. standard deductions
If you opt for a standard deduction during tax filing, you’ll deduct a single, flat amount of money from your income. The amount of money you can deduct depends on factors like your gross income, marital status, and number of dependents. Standard deductions save you the time and effort of calculation, recording, and reporting your expenses for the year. However, depending on your business, the standard deduction may save you less money on taxes.
Who can take the standard deduction?
There are a few restrictions on who can take the standard deduction. If you are a non-resident alien, you must itemize your deductions. The standard deduction is not an option. Also, if you are a married couple, and you are filing separately, you must both opt for the same type of deduction—standard, or itemized.
The top tax deductions for small businesses
One benefit of itemizing deductions? If you rack up a lot of deductible expenses in a specific category—say, for travel—they can significantly reduce your tax burden. Here are some of the most common and popular deductions small businesses take advantage of:
Advertising and promotion deduction
You can deduct 100% of what you spend advertising or promoting your business. That includes:
- Purchasing ad space in print or online media
- Launching a new website
- Hiring someone to design a business logo
- The cost of printing business cards or brochures
- Sending cards to clients
- Running a social media marketing campaign
- Sponsoring an event
However, you can’t deduct money paid to influence legislation (lobbying), or to sponsor political campaigns or events.
Business meal deduction
Generally, you can deduct 50% of qualifying food and beverage costs. To qualify, the expense must:
- Be an ordinary and necessary part of running your business
- Not especially lavish or extravagant (this depends on circumstances)
- Have the business owner, or an employee, present at the meal.
You can also deduct 50% of the cost of feeding employees—like buying sandwiches during an in-house workshop. Meals you provide at office picnics and parties are 100% deductible. Make sure you can back up this deduction with records—a copy of the receipt, including details on who was at the meal, their business relationship, and what you met about (broadly speaking).
Business use of your car deduction
If you use your vehicle solely for business purposes, you can deduct the entire cost of operating the vehicle. If you use it partly for work, and partly for personal reasons, you can only deduct costs associated with business-related usage. There are two ways to deduct vehicle expenses. Choose the one that gives you the greatest tax benefit:
- Standard mileage rate. Multiply the miles driven for business during the year by a standard mileage rate. Beginning January 1, 2019, the standard mileage deduction is $0.58 per mile. In 2018, it was $0.54 per mile.
- Actual expense method. Track all of the costs of operating the vehicle for the year, including gas, oil, repairs, tires, insurance, registration fees, and lease payments. Multiply those expenses by the percentage of miles driven for business.
Both methods require you to keep detailed records of your mileage. You can do this with a logbook or a mileage tracking app. Or you can go back retroactively, and put together a mileage log using other documents—like calendars and appointment books. Keep in mind, you can’t deduct the cost of commuting from home to your regular business place. This is considered a personal commuting expense.
When you make large purchases for your business—such as equipment or furniture—you’re required to spread the cost of those assets over the years you’ll use them, rather than deducting them all in one year. That being said, the IRS does give you a few ways to write off all of a depreciable expense in one year.
- De minimis safe harbor election. You can elect to expense assets that cost less than $2,500 per item in the year they are purchased. Read more about the de minimis safe harbor election in this IRS FAQ.
- Section 179 deduction. The Section 179 deduction lets business owners deduct up to $1 million of property placed in service during the tax year. This includes new and used business property and “off-the-shelf” software. The Section 179 deduction is limited to the business’s taxable income—claiming it can’t create a net loss on your return. But any unused Section 179 deduction can be carried forward and deducted on next year’s return.
- Bonus depreciation. Businesses can use bonus depreciation to deduct 100% of the cost of machinery, equipment, computers, appliances, and furniture.
If you bought a new vehicle during the tax year, and it’s a passenger vehicle, the IRS limits your write-off. In the first year, if you don’t claim bonus depreciation, the maximum depreciation deduction is $10,000. If you do claim bonus depreciation, the maximum deduction is $18,000. Depreciation is more complicated than other types of deductions. It’s a good idea to discuss large, depreciable expenses with your accountant.
Education expenses deduction
When education adds value to your business and increases your expertise, the cost is fully deductible. Some common valid business education expenses:
- Seminars and webinars
- Workshops to increase your expertise and skills
- Classes to improve skills in your field
- Subscriptions to trade or professional publications
- Books tailored to your industry
- Transportation expenses to and from classes
Keep in mind—if your education is in a field outside that of your business, or it’s preparing you for a different career, you can’t write off the cost.
Home office expenses deduction
Work from home? You may be able to deduct a portion of your housing costs. There are two ways to do this:
- The simplified method. You can deduct $5 per square foot of your home that is used for business, up to a maximum of 300 square feet.
- The standard method. Track all actual expenses of maintaining your home, such as mortgage interest or rent, utilities, real estate taxes, housekeeping and landscaping service, homeowners association fees, and repairs. Multiply these expenses by the percentage of your home devoted to business use.
To qualify for the home office deduction, your workspace needs to meet the following requirements:
- Regular and exclusive use. To pass the regularly and exclusively requirement, you must regularly use your home office exclusively for conducting business activities. A desk that doubles as your kitchen table won’t work. You don’t need to dedicate an entire room to your business, but your work area should have clearly identifiable boundaries.
- Principal place of business. Your home office must be your principal place of business. This means you spend the most time and conduct important business activities here.
If you use the standard method for calculating your home office deduction, you’ll need to file Form 8829 along with your Schedule C.
Legal and professional fees deduction
Necessary legal and professional fees that are directly related to running your business are deductible. These include fees charged by:
- Tax preparers
- Online bookkeeping services like Bench.
If the fees include payments for work of a personal nature (eg. making a will), you can only deduct the part of the fee related to business.
Retirement contribution deduction
You can deduct contributions to employee retirement accounts as a business expense. However, if you contribute only to your own retirement funds, you must claim the deduction on Schedule 1 (attached to your Form 1040). The amount you can deduct depends on the type of plan you have. For more info, check out the IRS’s tips for calculating your own retirement plan contribution and deduction.
How to file itemized deductions
To file itemized deductions for your sole proprietorship, list them on Schedule A of Form 1040.
Limitations on itemized deductions
Some deductible expenses come with limitations. The most common are:
- Medical and dental expenses. While you can deduct medical and dental insurance premiums for yourself, your spouse, and your dependents, you are unable to do so if you participate in a plan through your spouse’s employer.
- State and local income and property taxes. You can deduct the cost of state and local income taxes on your federal return, but the Tax Cuts and Jobs Act limits this deduction to $10,000 or less.
- Home mortgage interest. If you work from home, you can deduct a percentage of your mortgage interest that coincides with your business use. For instance, if you use 10% of your home for business, you can deduct 10% of the cost of your mortgage interest.
- Casualty and theft losses. If your assets are lost, destroyed, or damaged, you can deduct the amount that is not reimbursed by insurance. However, the event needs to be sudden, unexpected, and unusual. You’re also required to file a claim with your insurance provider, if applicable.
How to file the standard deduction
You elect to file for the standard deduction on IRS Form 1040. To find out how much your standard deduction is, you can fill out an IRS survey online.
Should you itemize, or use a standard deduction?
Ideally, you should choose to take whichever deduction—itemized or standard—is greatest. Choosing, however, is something of a catch-22. After all, you won’t know whether you stand to benefit more from an itemized deduction than a standard one unless you add up all your deductible expenses for the year—roughly, at the very least. That’s why it’s a good idea to enlist the help of a CPA when it’s time to choose a deduction. So long as your bookkeeping is up to date, they’ll be able to crunch the numbers and choose the best deduction for your business.
Good bookkeeping helps you get more tax deductions
When you’ve got a comprehensive bookkeeping system in place, you track and categorize all of your business expenses. That makes it relatively easy to figure out your deductible expenses for the year. You won’t need to go back and dig through old expenses, categorizing them after the fact, figuring out which you can deduct and which you can’t. Good bookkeeping is especially important when depreciating large purchases—it’s almost impossible to plan and file depreciation expenses without it. If you’re thinking of securing a loan to make a large purchase, you need to be sure your bookkeeping is set up properly. Bottom line: Paying for bookkeeping now will save you money at the end of the year. You’ll benefit from every deduction available to your business. And, on top of that, the cost of bookkeeping is itself 100% tax deductible. Whether you should choose the standard deduction for your business, or itemize your expenses, depends on which method will save you the most money. If you need help figuring that out, try hiring an accountant.
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