You spend a lot on your business. Thankfully, the IRS allows you to deduct business expenses to lower your taxable income. Said another way: the more deductions you have, the lower your taxable income and the less income tax you pay.
But what business expense qualifies for this deduction? What does the IRS consider as reasonable business expenses? We'll cover what every self-employed, freelancer and small business owner needs to know.
Most of the work involved in doing your taxes will go into determining what deductions you can take, how much you can take, and when you can take them. You don't have to become an income tax expert. But even if you have a tax professional prepare your tax returns, you need to have a basic understanding of what expenses are deductible so that you can keep proper records.
This takes some time, but it's worth it. There's no point in working hard to earn a good income only to miss deductions to which you are entitled and turn over more of your income to the government than required.
Virtually any expense is deductible as long as it is:
An expense qualifies as ordinary and necessary if it is common, accepted, helpful, and appropriate for your business or profession. An expense doesn't have to be indispensable to be necessary; it need only help your business in some way, even in a minor way. It's usually fairly easy to tell if an expense passes this test.
An expense must be related to your business to be deductible. That is, you must use the item you buy for your business in some way. For example, the cost of a personal computer is a deductible business expense if you use the computer to write business reports.
You cannot deduct purely personal expenses as business expenses. The cost of a personal computer is not deductible if you use it to play computer games. If you buy something for both personal and business reasons, you may deduct the business portion of the expense.
For example, if you buy a cellular phone and use it half the time for business calls and half the time for personal calls, you can deduct half the cost of the phone as a business expense. However, the IRS requires you to keep records showing when the item was used for business and when for personal reasons.
There is usually no limit on how much you can deduct as long as it's not more than you actually spend and the amount is reasonable. Certain areas are hot buttons for the IRS, especially entertainment, travel, and meal expenses. The IRS won't allow such expenses to the extent it considers them lavish.
Also, if the amount of your deductions is very large relative to your income, your chance of being audited goes up dramatically. You're relatively safe as long as your deductions don't exceed about half of your revenue. If you have substantial deductions, make sure you document them as proof of record.
You are allowed to deduct 50 percent of business meals. To get this write off, you must discuss business during the meal.