Deducting your business expenses when you do your income taxes can be quite valuable because the more deductions you have, the lower your taxable income will be. Let’s walk through how to deduct your business expenses on your tax return without drawing any red flags from the IRS.
How to Deduct Business Expenses on Your Tax Return
It’s very easy to deduct your business expenses when you do your income taxes. You simply keep track of everything you buy (or spend money on) for your business during the year, including the amount spent on each item. Then you record the expenses on your tax return.
The vast majority of self-employed people are sole proprietors. A sole proprietorship is a one-owner business. You can’t be a sole proprietor if two or more people own the business (unless you own the business with your spouse). Unlike other business forms like corporations and partnerships, a sole proprietorship has no legal existence separate from the business owner. The business owner (proprietor) personally owns all of the assets of the business and controls its operation. If you’re running a one-person business and you haven’t incorporated or formed a limited liability company, you are a sole proprietor.
If you are a sole proprietor, you report your business income and claim your business deductions by filing IRS Schedule C, Profit or Loss From Business with our personal tax return. To make this task easy, Schedule C lists common expense categories—you just need to fill in the amount for each category.
The Schedule C categories include:
- bad debts
- car and truck expenses
- commissions and fees
- depletion (rarely used by most small businesses)
- depreciation and Section 179 expense deductions
- employee benefit programs
- insurance (other than health)
- legal and professional services
- office expenses
- pension and profit-sharing plans
- rent or lease—vehicles, machinery, and equipment rent or lease—other business property
- repairs and maintenance
- taxes and licenses
- travel meals and entertainment
For example, if you spend $1,000 for business advertising during the year, you would fill in this amount in the box for the advertising category. You add up all of your current expenses on Schedule C and deduct the total from your gross business income to determine your net business income—the amount on which you are taxed.
Reporting Transportation Expenses on Schedule C
If you deduct the interest you pay on a car loan, you have the option of reporting the amount in two different places on your Schedule C: You can lump it in with all your other car expenses on line 9 of the schedule, titled “Car and truck expenses,” or you can list it separately on line 16b as an “other interest” cost. Reporting your interest expense separately from your other car expenses reduces the total car expense shown on your Schedule C. This can help avoid an IRS audit.
You must also file IRS Form 4562, Depreciation and Amortization. This form is used to report your Section 179 and depreciation deductions for the vehicle.
Filing Schedule C-EZ
The IRS has created a shorter one-page version of Schedule C called Schedule C-EZ. As the name implies, it’s intended to be easier to use than Schedule C. You can file Schedule C-EZ only if you have a profit from your business and:
- your expenses are not greater than $5,000,
- you have no employees,
- you have no inventory, and
- you are not using depreciation or deducting the cost of your home you can use Schedule C-EZ.
If You’ve Formed a Business Entity
If you are a limited liability company owner, partner in a partnership, or S corporation owner, the process is very similar to being a sole proprietor, except you don’t use Schedule C. LLCs and partnerships file IRS Form 1065, U.S. Return of Partnership Income, and their owners’ share of expenses is reported on Schedule K-1. S corporations use Form 1120S, U.S. Income Tax Return for an S Corporation. Each partner, LLC member, and S corporation shareholder’s share of these deductions passes through the entity and is deducted on the owner’s individual tax return on Schedule E. Regular C corporations file their own corporate tax returns.
MileIQ’s blog does not constitute professional tax advice. You should contact your own tax professional to discuss your situation.