Running a small business puts serious demands on your time, energy, creativity, and talent. Knowing where you are financially is a critical component. Whether you are a freelancer, independent contractor, or have a side business, you probably have a good sense of what your business income stream looks like.
However, where the money goes is often a little foggier. And how those business expenses fit into your tax picture may be even more mysterious. Properly tracking your business expenses is very important come tax time, especially if you’re to get the most out of your tax returns.
Take a look at the following guide to Schedule C deductions, and you may find that you’re missing out on some key tax deductions for self-employed freelancers and small business owners.
The expenses for all forms of advertising can be placed under line 8 in Part II (Expenses) of Schedule C. This essentially includes anything you did to earn new business or increase sales to past customers that can’t be categorized elsewhere.
Some examples of deductible advertising expenses include:
- Purchased email lists for sales through direct-mail marketing
- Manufacturing expenses of promotional items, such as pens, calculators, calendars, and notepads
- Printing costs for banners and business cards
- Online advertising or website costs
Vehicles and Machinery
The use of various vehicles and machinery is often required to run a business. Be sure to keep an eye on how much you spend in these areas throughout the year so that you can make deductions later:
- Cars and Trucks. Line 9 can be used to deduct either the actual expenses of operating your car or truck (such as gas and oil, repairs, license, registration, insurance, and tires) or the standard mileage rate, which for tax year 2017 is 53 cents per mile. For a given vehicle, you can claim either actual expenses or the standard mileage rate if you took the standard mileage rate the first year the car was placed in service. Keep in mind, if the vehicle is for personal as well as business use, you can only deduct the miles that were driven for business purposes. You need to maintain a written mileage log to document the business miles driven for the year. You can’t use the standard mileage rate if you use your car for hire (such as for a ridesharing service) – you can only take actual expenses. The same applies if you are using five or more cars at once. Whether you take actual expenses or the mileage deduction, you can still deduct parking fees and tolls.
- Rental or Lease of Vehicles, Machinery, and Equipment. If you leased any equipment or vehicles, you can deduct the cost on line 20. If you leased a car for 30 days or more for business purposes, see the section on leasing a car in Publication 463 for guidance. This is also an area where you may want to get an accountant involved.
Wages, Commissions, and Fees
If you run a small business, you may have to hire people for various tasks. Some of these may be regular, full-time employees; others might be contract workers or consultants. The good thing is, you can claim the money you spend paying these people:
- Wages. You can deduct all the money you paid to employees as wages by using line 26. However, you can’t deduct money you paid to yourself or any money deducted elsewhere in your return. You should also subtract any amounts you received as a credit from the Work Opportunity Credit, Empowerment Zone and Renewal Community Employment Credit, Indian Employment Credit, or Credit for Small Employer Pension Plan Startup Costs. Make sure that anyone whose wages are included on this line receives a W-2 from you as well.
- Independent Contractors. Payments to contractors, freelancers, or other small business people can go on line 11. You must send Form 1099-MISC to those whom you pay $600 or more. Copies of the 1099-MISC and Form 1096 (Annual Summary and Transmittal of U.S. Information Returns) must be sent to the IRS.
- Legal, Accounting, or Professional Services. If you used the services of a lawyer, accountant, tax preparer, doctor, graphic designer, or other professional, their fees can be deducted on line 17. This refers to companies who provided a service (such as designing a new logo), as well as companies that manufacture a physical product (such as business cards or signs with the new logo). If you have an accountant, the fees they charged for tax preparation can be split – those for preparing your Schedule C can be deducted here, and the cost for preparing the rest of your personal return can be deducted as a miscellaneous deduction on Schedule A, subject to the 2% of AGI floor.
- Commissions and Fees. Line 10 is a sort of catchall category for any money you paid to other businesses or individuals for services. An example might be commissions you paid to salespeople.
Depreciation and Section 179 Expense Deduction
Line 13 is the place to enter depreciation. “Depreciation” refers to deducting the cost of a large purchase in portions over its useful life, instead of in one lump sum in a single year. You must begin depreciating the cost of the item in either the year you bought it or the year you started using it.
IRS Notice 2015-82 increased the safe-harbor amount for expensing, rather than depreciating, tangible property from $500 to $2,500. You can continue to depreciate items over their useful life, if you choose, but you can expense items up to $2,500 as of January 1, 2016 without it affecting Section 179 annual limit for spending cap.
The Section 179 Expense Deduction allows you to deduct the full value of most tangible items in a single year instead of spreading it out. If you are depreciating any items, see Publication 946 for more information.
Employee Benefit Programs
Since you are self-employed, you can deduct your own medical, dental, or long-term care insurance premiums on line 29 of your 1040. This can also include premiums for your spouse and children (under 27 years old at year’s end – even if not a dependent). The net profit of your business must be equal to or greater than the premiums. This deduction on your personal tax return is called “Self-Employed Health Insurance.”
You can also deduct premiums you paid for employees on line 14 of your Schedule C. This includes things like health insurance, group term-life insurance, accident insurance, or childcare assistance programs.
Contributions you made on your employees’ behalf to pension or retirement plans can be deducted on line 19. These can include SEP, SARSEP, SIMPLE, or 401k plans. See IRS Publication 560 for further information on these plans. There is a business credit available for establishing a retirement plan for employees. See Form 8881, with its instructions, for additional information. The credit is limited to $500 per year for up to three years.
Compliance with Department of Labor regulations may become part of your business life if you establish benefits plans. So, you might at least consider using a third party to make sure you are coloring within the regulatory lines. Ordinarily, you would file Form 5550 with the Department of Labor.
Insurance (Other Than Health)
You can deduct the cost of any insurance you carry strictly to protect the business (such as general liability business insurance, or errors and omissions insurance) on line 15. If you have a home office and pay renters’ insurance or homeowners’ insurance, don’t deduct it here – instead, deduct that as part of your home office deduction.
Do you have property for business use that is secured by a mortgage? If so, the interest noted on Form 1098 that you received is deductible on line 16a. If you used money from a loan secured by a home mortgage for business use, you can deduct a portion of that interest here also. You should consult IRS Publication 535, “Business Expenses,” Chapter 4, for help with figuring the interest allocation that can be deducted here. Remember also that if someone else helped pay the loan, you must split the deduction with them.
Interest paid on other business loans, as well as for small business credit cards, can be deducted via line 16b.
The costs of maintaining the property where your business is located can add up throughout the year. Luckily, you can deduct these costs:
- Rent or Lease of Other Business Property. This one is pretty straightforward. On line 20b, you can deduct any amount you paid in renting or leasing office space, warehouse space, or other real estate. Rental of vehicles, machinery, or equipment goes on line 20a. However, see IRS Publication 463 if you leased a vehicle for more than 30 days. You may have to subtract an “inclusion amount” from your deduction to account for depreciation.
- Repairs and Maintenance. Line 21 covers any costs incurred in repairing or maintaining your machinery, property, or buildings that don’t actually add to its value. If it adds to value, or you are restoring something unusable to a usable state, or you are replacing something, you cannot deduct those costs here. These expenses may need to be capitalized and depreciated. Repair would include expenses like paying a plumber to fix the bathroom in your deli, not paying a plumber to install an additional sink in the bathroom.
- Utilities. Line 25 covers any utility payments your business makes (separate from those that may be included in your rent or lease), such as electricity or gas. Phone service is also considered a utility. If you take the home office deduction, you may include phone service either here or there, but not in both. But be careful, the first landline to the home is not deductible, though long-distance costs for business purposes on that line are.
Expenses incurred from purchasing office supplies – such as postage, paper, envelopes, and pens – can be claimed on line 18. Other miscellaneous supplies the business consumes can be claimed on line 22. Examples of these might be toilet paper, cleaning supplies, coffee for employees and customers, small hand tools, or first aid kits.
Items like technical manuals or small equipment that will need to be replaced every couple of years can also be deducted here. This line is something of a catchall, and therefore you should make an effort to ensure nothing overly expensive ends up in this category.
Taxes and Licenses
On line 23, input the sales taxes you have paid as the seller of goods or services. However, if you collected these taxes directly from the buyer, those amounts must be included in gross receipts on line 1.
Other deductions that fall here include:
- Licenses or regulatory fees (liquor licenses may need to be amortized due to cost and duration)
- Federal Unemployment Tax
- Social Security and Medicare taxes paid for your employees
- Real estate and personal property taxes on your business assets
- You cannot deduct federal income taxes here, although you can deduct half your self-employment tax on your 1040, line 27. You also can’t deduct estate or gift taxes or assessment taxes for improvements to your property. Generally, assessment taxes add to your basis in the property and are not deductible. Note that sales taxes that you pay on items for use in your business should be included in the cost of those items.
Travel, Meals, and Entertainment
- Business Travel. If you go on a business trip, your hotel, plane ticket, taxi fares, parking, and tips for the bellboy are all deductible using line 24a. You must keep your receipts for all these items, as this is one area that the IRS frequently audits. Expenses that are “extravagant or lavish” will be disallowed. As for travel outside North America for a business convention or other meeting, it’s deductible if the convention is directly related to your business and there’s a good reason for it to be held outside the continent. More detailed information on this can be found in IRS Publication 463, “Travel, Entertainment, Gift and Car Expenses.”
- Business Meals and Entertainment. Since, presumably, you would need to eat in any case, you may deduct only 50% of the cost of meals consumed for business purposes on line 24b. This includes meals with your clients. “Lavish or extravagant” meals are not deductible, though the IRS does not specify exactly how big the steak may be. You or an employee must be present at the meal – you can’t just send a client to dinner and bill it to your room and deduct the cost. Also, even though you may swear you do all your best deals while attending Major League Baseball games, you are still only permitted to deduct 50% of the cost of entertainment. Documentation is important: You should keep a record of the date, place, attendees, business purpose, and cost.
Line 27 is the real catchall. On the second page of Schedule C, you can list “other expenses.” You still need to put them into categories, but you can put items here if you’re not sure they fit into one of the lines provided. For example, you might list postage here, since there is not a separate line item for that (although you could include it under “office expense”). Your cell phone or Internet expense might also be listed here.
You’re still required to make sure any expenses you list are reasonable and necessary for your business. If you truly can’t fit some expenses into any other category, the IRS gives you a place to create some of your own.
There are several other things you must keep in mind when preparing your return:
- What’s included in “other income” on line 6? The line for “other income” is for income that might be considered “non-sales” income. This includes bad debts you wrote off in prior years but recovered this year, prize money your business won, any interest paid to you (such as on past due accounts), or any tax refunds or tax credits related to using renewable fuels. This is also the place to enter recaptured depreciation on listed equipment (like computers), the business usage of which dropped to below 50%.
- If you paid any sales tax on items that you bought for the business, the sales tax is considered part of the cost of the item. Thus, you deduct it wherever you’re deducting the cost of the item. Sales tax on purchased items is not treated separately and entered on the line for “Taxes & Licenses.”
- You as the business owner are treated differently from other employees (even if you are self-employed). While there are dedicated lines on Schedule C for your employees’ wages, health insurance, and retirement plans, your own costs in these categories are not included. Your cost of health care can be deducted on your 1040, line 29. Similarly, your Self-Employed Pension or SIMPLE plan contributions are deducted on Form 1040, line 28. For deductions and limits, see IRS Publication 560, “Retirement Plans for Small Business.”
- The best way to ensure you get your mileage deduction is to keep a log. You should write down your odometer reading at the beginning and end of the trip, as well as the date and what you were doing. IRS agents are easily impressed if you’ve got pages and pages of this stuff. There are several apps, such as MileIQ, for tracking mileage that use your phone’s GPS. Some of the apps are free, while others offer premium plans with added features.
If you keep these things in mind and track your expenses carefully, you’ll be in good shape to really take advantage of your deductions.
How do you track your expenses throughout the year?