***This information is not tax advice, but information only. Consult your tax professional for all applicable tax benefits for your company.***
Planning for Income Taxes are a necessary part of any business owner’s financial strategy. And contrary to some opinions, it is a wonderful thing to show a profit and pay taxes. That means YOU are making money. But let’s get real - no one wants to pay more than they must. The following are some guidelines from the Internal Revenue Service to help you make the most of allowable tax benefits for self-employed and small business owners.
I mean this article only as a resource and not a comprehensive outline for tax planning. Again, consult your tax professional for complete details.
Reminder: The extended deadline of July 15, 2020 to file your 2019 income taxes provides an excellent opportunity to review and plan for your 2020 taxes.
PROVE YOUR PROFIT
The IRS states, at the top of its requirements, that you MUST be in business to earn a profit. You do not need to actually make a profit to be in a trade or business as long as you have a profit motive. However, the IRS will only allow you to claim losses for 3 out of 5 tax years. If your business claims a net loss for too many years, the IRS may classify it as a hobby, and if you can't prove that you had a valid profit motive, you won't be able to claim business deductions. This is one of the key reasons it is important to prove you want to make a profit in business. (You don’t want to face an audit, do you?)
So, what can you deduct?
ORDINARY EXPENSES - or what is an OPEX?
Ordinary expenses are just that - any expense required to carry on your business. Not only does it need to be ordinary - it needs to be necessary. ORDINARY EXPENSES are expenses involved in the day-to-day, right now operation of your business.
Think internet. Be careful deducting clothes and how you calculate home office spaces though. Even if you are a cowboy or cowboy adjacent business, doesn't mean you can deduct your cowboy boots if you could also use them for personal reasons. If you work from home, but don't have a dedicated space, you can't count it as a deduction (see below for more about The Great Divide).
The following categories do not count as “ordinary expenses.” Another part of the tax code covers them.
Expenses used to figure the cost of goods sold.
Capital Expenses
Personal Expenses
COGS - are those just parts of a wheel?
Do you manufacture goods or purchase them for resale? If so, make sure you have an inventory of what is on hand at the beginning of the year. The expenses to manufacture, store and ship products are a few of the items you can deduct under Cost of Goods Sold. However, you can’t count these as business expenses, too. One or the other - not both.
*For additional information, refer to the chapter on Cost of Goods Sold, Publication 334, Tax Guide for Small Businesses and the chapter on Inventories, Publication 538, Accounting Periods and Methods.
CAPITAL EXPENSE - or does that count as a CAPEX?
To make it simple, a Capital Expense is the purchase of anything for the FUTURE BENEFIT of your business. Capital Expenses are assets rather than liabilities. These assets can be tangible, such as a new building or upgrading your current business location, or intangible, a patent or recipe. These assets are depreciable according to the IRS guidelines.
THE GREAT DIVIDE: PERSONAL or BUSINESS EXPENSE?
As a general rule, you cannot deduct a personal expense as a business expense. However, there are times those expenses overlap.
For example: If you work at the dining room table where you and/or your family eat or you're like my husband who likes to work on the couch in the living room, you can't count the space as your home office (unless you only used the space to work). My home office also serves as the guest room. I have other rooms in the house I could have worked in that would provide me a bigger deduction but this room allows me to see out the front window, giving me a view other then the brink wall the windows in other available rooms offer, and that's where our dog likes to spend her day ( I call the guest bed my dog's office). I also keep client and office supplies in the dresser and closet. So what's deductible? The 6'x6' area my desk and chair takes up is what we claim. Everything else in my office serves as a duel purpose, including the closet. Could I deduct more? Maybe. But I'm mitigating risk by following the guidelines set forth by the IRS and if they were to knock on my door today, my concern for that deduction is low.
Other areas of overlap are the business use of your vehicle, computer, and cell phone. It is important for you to keep written records to differentiate the business and personal uses. Typically, these expenses are an indirect expense of the total use.
MORE EXPENSES TO CONSIDER
Employee's Pay
Retirement Plans
Rent Expense
Interest
Taxes
Insurance
This is not a comprehensive list, nor a complete overview of all that may qualify as deductions for your business. Publication 535 of the IRS Guidelines discusses what are, and what are not, approved deductions.
Would you like some help making sense of all of these terms and deductions? Schedule a discovery call with Waggoner Professional Services to see how we can help you make the most of your pre-planning strategies and how to track these expenses to make the tax preparation process easier.
*Cited from the Internal Revenue Service guidelines for small business and self-employed taxpayers.