Tax season is upon us, but as a new business owner you must realize that all year is actually tax season. Keeping these tips in the back of your mind will keep you ahead of the game and organized when it comes time to officially file. While reading through this list remember that these are just general tips and should never take the place of advice and guidance from a seasoned tax professional. So before launching any strategy or taking any deduction, consult a pro so you don’t get in trouble with the man. This may be a lengthy read for some, but taking the time to learn how to properly file taxes as a new business owner is worth the extra couple of minutes.
1. Business Structure
How you set up your business will effect how you pay taxes on your income. As a sole proprietor you will pay self-employment taxes on the entire amount that you earn. If you decide to go the LLC route, you can then elect what to be treated as a “S Corporation” or “S Corp” for short, which can help reduce your self-employment taxes. You can do this with an S Corporation because you are allowed to pay yourself a “reasonable” salary, which is subject to employment taxes such as FICA, Medicare and Social Security, and then any remaining profits can be taken as a profit distribution or “dividends”, which are not subject to to those employment taxes.
For example, you are a web designer and as a sole proprietor made $50,000 last year. You would have to pay employment taxes on the whole amount. Let’s say this year you decide to form an LLC and file for S Corp status. You marketed and worked hard and this year made $75,000. Now you pay yourself the average salary of a web designer out of that money, say $40,000, which is subject to employment taxes, and the remaining $35,000, you pay yourself as a distribution of the profits, which is not subject to to those same employment taxes.
2. Upgrades for Your Office
Have you been thinking about buying some new stuff for your office? Whether its a chair, desk, bookcase, or other office furniture, remember that all of these are allowed as deductions. Anything required for the actual function of the office fits the bill, something decorative like a house plant or wall hangings, not so much. There are two ways to claim these deductions: all at once at the end of the year when you file, or over the life of the item/property, which is known as depreciation deductions.
The IRS form you need: Pub 946: How to depreciate property
3. Deducting Your Home Office
In order to qualify a portion of your home as a deduction, it must be used exclusively for business activities. Therefore your kitchen counter does not qualify for a “home office”. But, if you have a dedicated room or even a part of a room for an office, the you will be able to deduct some of your housing costs.
To give you an idea on how it works lets use an example. Steve, a sales consultant, uses an extra room in his home as an office. His house is 1,800 sq. ft. and the room itself is 144 sq. ft. or 8% of the total living space of the house. He is now able to deduct 8% of certain home expenses, including his mortgage and insurance.
In 2014, the IRS changed this process to a much more simplified version. Now when claiming your home office deduction, you no longer have to calculate percentages. The new way is to simply claim $5 per square foot of office space, up to 300 sq. ft.
An item of note here is that many say claiming a home office deduction is a big red-flag and increases your chances of an audit by the IRS. With that said, if you are legally entitled to the deduction, take it! Just make sure you do not exaggerate your claims and you will have nothing to worry about if it comes down to an audit.
The IRS form you need: Form 8829: Expenses for Business Use of Your Home
4. Office Supplies
So we now know that you can save some tax dollars if you have a dedicated home office, but did you know that you can also deduct everything you need to run that office: paper, ink and toner, postage supplies, etc. You can fully deduct all of these as long as you can prove that they are being used for your business. Did you buy a new computer or tablet? These can also be deducted in one of two ways. One, if you have more than one of these units in your home you can deduct the entire cost of one of them. Two, if you only have one computer/tablet in your home, then you can deduct the percentage of use it gets for business reasons, because more than likely it is used for things other than business.
The IRS form you need: Publication 535 Business Expenses
5. Your Home Utilities
If you are utilizing the home office deduction, you will also be able to write off a portion of your home utilities such as your heating and electric bills. The amount that you can deduct will be the same percentage as the one described in number 3 above. You will also be able to deduct a portion of your other bills, such as your internet/broadband. When doing this though, you must remember that more than likely, these services are not used 100% for business reasons and therefore cannot deduct the entire amount off, only the percentage of time these are used for business. A fairly standard amount would be 50%.
6. Your Car and Commute
When working from home, you can’t beat the commute. This also means that there is no mileage from a commute to deduct. But if you are driving to meet a client or perform your job at a different location (this does not mean your local coffee shop, rather a place of business or client’s location), or out purchasing those business supplies from number 4, you can deduct your travels. This includes the standard mileage deductions allowed by the IRS, parking, and tolls.
The IRS form you need: Pub 463 Travel
7. Business Lunches
Speaking of travel, what if you are meeting a client for a business lunch? Can you use the lunch as a deduction, YES! Can you deduct the entire price of that lunch, no. What most people don’t know is that you can only deduct 50% of the meal, not the entire thing. This is also an area that the IRS scrutinizes very carefully, so no $500 bottles of wine or private jet trips to Vegas. Be realistic in your meals and outings, keep receipts, notate on the receipts the client you were with and any notes about the meeting, and you should be fine.
The IRS form you need: Pub 463 Entertainment
8. Fancy New Health Insurance?
If you are self-employed, then you may be able to deduct the cost of health insurance for yourself and your immediate family. If you are eligible to participate in an employer subsidized plan through your spouse or partner, then you will not be able to deduct the cost of your insurance.
The IRS form you need: Pub 535 Business Expenses
9. Travel Expenses
Much like dining out with clients in number 8, knowing what you can deduct on business trips can keep more money in your pocket and help you stay prepared for the IRS in case any audit should come your way.
So did you plan on attending an industry conference this year or travel to meet a client that was out of town? As long as you were not reimbursed for the travel by someone else, you can safely deduct these costs. With that said, here are some general rules you should know:
- You can deduct 100% of any travel expenses such as a plane ticket, parking, taxis, and even a rental car.
- You can deduct 100% of your lodging (ie. Hotel) and tips
- And like we said in number 8, 50% of your meals on business days
Another great tip, if you have business that starts on a Friday and ends on a Monday, you can deduct your expenses over the weekend!
The IRS form you need: Pub 463 Travel
10. Your Retirement
Even though you may just be getting started and you aren’t exactly rolling in cash, it’s imperative that you keep your end goals in the back of your mind, which for many includes retirement. Talk to a professional about the various tax-deferred retirement plans available to you, and even if you can’t contribute much, it is a way to lower and defer your tax bill.
IRS info on retirement plans: Retirement plans for self-employed people
Well there you have it folks. I know you have a lot on your mind with a new business on the plate, but knowing some basic ways to save some cash and some easy ways to lower your tax bill legally can really help take some pressure off. As always, refer to a tax pro before taking advantage of write-offs and deductions. That way you can understand all of the rules behind each one. Trust me, it’s not easy when the United States Tax code is over 70,000 pages long. As always, keep grinding!