Tax-deductible business expenses are fairly straightforward. Whatever is ordinary –meaning that similar businesses would incur this expense — and necessary for operating your business is likely to fall into the deductible category. Office equipment, business-telephone line, advertising, stationery and business cards are some of the obvious expenditures.
As a sole proprietor (meaning you haven’t taken steps to incorporate as an S corporation, C corporation or limited partnership), you’ll use Internal Revenue Service form Schedule C to list your business expenses. Ms. Zobel advises you to be as specific as possible, noting that $5,000 in “supplies” is likely to be red meat to a tax auditor. Breaking that down into, say, copier paper, computer software, or however you spent your cash is a better course. If you pay for these items with credit, the interest is deductible, but not the principal amount of the loan.
The IRS doesn’t require sole proprietors to have a formal bookkeeping system, says Ms. Zobel, though in the event of an audit, agents will, of course, seek documentation of these expenses, such as canceled checks, receipts and so forth. They will also look for reasonable proof that these are legitimate business expenses.
Your second question — when to declare these expenses — is trickier in your case, says Ms. Zobel. If you are just starting out, your business may not have a cent of revenue. Tax preparers differ on this question, but Ms. Zobel strongly advises you to wait until you can ring up some business income before you begin deducting business expenses. “I rarely will fill out a Schedule C (for itemized business expenses) for someone who has only business expenses and no business income, as I think this calls attention to the entire tax return,” she writes. Who wants to provoke an audit?
Bigger items, something with a useful life longer than a year, must be depreciated. Depreciation means deducting its value, bit by bit, over 60 months. But don’t despair over depreciation, because you may not have to worry much about it. A sole proprietor’s expenses are likely to fall under Section 179 of the tax code. This means you can fully depreciate it — deduct the entire amount — up to $100,000 (a recently revised figure) in the year you bought it. “Almost nothing wouldn’t fit under Section 179” for a start-up, Ms. Zobel says.
Ms. Zobel, the expert in the quote, is a tax practitioner with offices in Oakland and San Francisco California. She has been doing taxes since 1978 and has prepared over 8,000 returns. Jan is an enrolled agent (a tax preparer licensed by the IRS.)
Although she prepares all types of individual returns, Jan specializes in working with self-employed people and independent contractors. Many of her clients are one-person service businesses such as psychotherapists, graphic artists, computer consultants, etc. In addition to doing tax preparation, Jan teaches a 6-hour class called Basic Tax and Recordkeeping Information for Self-Employed People. In recognition of the value of this class to entrepreneurs, the Small Business Administration named Jan Accountant Advocate of the Year. She also is the author of Minding Her Own Business: the Self-Employed Woman’s Guide to Taxes and Recordkeeping (SourceBooks) and her tax articles regularly appear in local and national magazines and newspapers.