Tax deductions: You’ve heard of this elusive unicorn of the self-employment world that’s *supposed* to help you save money buuuuuut you’re totally lost about how these things work and what even counts as a tax deduction. Because true story- when are you actually supposed to learn about this stuff?!
On the Andi Smiles Show of course!
I’m talking about the 3 types of tax deductions that small business owners can write off and how to keep track of them.
Join me every Wednesday 12pm PST on good ‘ol Facebook for the next episode of The Andi Smiles show!
Don’t want to remember things (‘cause- ugh- things)? Get a reminder when I go LIVE by clicking here and I’ll send you a message via Facebook Messenger right when the shows starts (plus you’ll have the replay link in your pocket!).
What are tax deductions? (4:05)
So, I want to be clear here. We’re not going line by line for every single tax deduction. These are more three umbrella categories that all of these different tax deductions fall under.
Before you take a super fun dive into the tax deductions that can save you money, let me answer one important question. What the heck are tax deductions?
Well to be quite simple, tax deductions are the love of your tax filing life! We all love them. But, why?
Tax deductions are your business expenses! These are the expenses that you incur as the owner of the business to operate, maintain, and grow your business.
Here’s the thing about tax deductions and why we love them so much… They impact how much you pay in taxes at the end of the year. When we file our taxes we do three things.
The first thing we do is report all of the money we made. We report our gross revenue or gross incomean which shows all the money that we have made for whatever we do or sell.
The second thing you do is report all of the expenses you incurred to make the money that you made. These are our tax deductions or just our business expenses.
The last thing that happens is that you get your taxable income and your taxable income is generally pretty akin to what we call your net income. Your net income is your gross income minus expenses. What’s left after expenses is your net income. When you file your taxes, your adjusted gross income which is your taxable income follows that same formula.
Your tax deductions are going to impact how much you pay in taxes at the end of the year. If your net income or adjusted taxable income is higher, you will pay more taxes. If it’s lower you will pay less taxes which is why we focus on how to maximize deductions. Maximizing deductions is making sure that you’re writing off everything that you can take for your business that’s appropriate. It’s about really being clear on what you can take so you’re not missing deductions and paying more in taxes.
The biggest takeaway here is that tax deductions are your friend. They may seem kind of scary and overwhelming. You may be feeling like tax deductions are too much to figure out but ultimately tax deductions are your BFF. Give them the time of day. You want to get to know them very well, especially during tax time.
Ordinary Tax Deductions (7:23)
The first umbrella of tax deductions are called ordinary deductions. These are deductions that are typical to all businesses.
Now let’s back up a little bit because if you’re in the U.S. you pay taxes to the IRS and there’s a way that the IRS describes what a business expense or tax deduction is. They describe that these are expenses that are ordinary and necessary for your business.
What’s nice about ordinary business expenses is that you don’t have to do a whole lot of justification around it. You don’t have to explain so much of why a particular expense is so important.
An example of an ordinary tax deduction or ordinary expense could be advertising and promotion. It is expected that for businesses to make money we have to advertise ourselves. We need to market ourselves so you don’t need to justify the fact that you’re advertising and marketing yourself. That’s an ordinary business expense.
One of the things to keep in mind about these ordinary business expenses is that they tend to transcend industries. It doesn’t matter if you are a bookkeeper or an Etsy seller, we both need to advertise ourselves.
Let’s take a peek at a few more examples of ordinary business expenses.
Another type of ordinary expenses is meals and entertainment. It’s expected that at some point in your business you’re probably going to take out a colleague, client, or contractor for a meal. You don’t need to justify that. This is common business practice
Another example is office expenses. If you have a business you need to have paper. You need to have pens. You need to have filing folders. It does not matter what type of business you have. You’re not going to make a case for why you bought a printer ink cartridge. See how these are just ordinary expenses that pretty much any business has?
So, how do you know if something is an ordinary business expense?
Ask yourself, “Do other businesses have this expenses? Is this something that other businesses would typically be spending money on?” If the answer is yes, then you’re in ordinary expense land. You generally want to think about if it transcends industries as I mentioned. If it transcends industries, again you’re in ordinary expense land.
So, how do you keep track of all those ordinary business expenses?
Use your business account. Anything that’s an ordinary business will be paid for out of your business account. So if it’s ordinary- use your business checking account to pay for it and then in your bookkeeping program categorize it with the appropriate category.
I know sometimes we get really doubtful especially in the early stages of our business about pretty much anything tax related. It’s easy to second guess ourselves in the assumptions we make about our expenses- when in doubt, stay calm and use your business card!
Industry Specific Deductions (13:02)
The next category of deductions is industry-specific deductions. These can also be a place where we start to get a little bit confused about tax deductions. Remember how I said that the IRS considers a business expense something that is ordinary and necessary for you to run your business? Well, now we’re talking about the necessary part.
Industry-specific deductions are expenses that are necessary for your business. Someone in one industry is going to have expenses that differ from someone in another industry. This is the necessary part. What’s necessary for one person’s industry isn’t actually necessary for another person’s industry.
Let’s talk deets:
If you’re starting a sewing business and need to buy an industrial sewing machine and a bunch of sewing supplies, you can write that off because it specifically relates to your industry. Now if I tried to write off a sewing machine for my business it would make absolutely no sense because there is nothing in my industry that requires that I have a sewing machine.
See how the deductions are based on your industry? Here’s another example:
Let’s say you’re a tattoo shop owner. A tattoo shop owner will have tattooing supplies like needles, medical supplies, paper towels, and ink. Again, these are very specific supplies for this industry.
Another example is a photographer. A photographer is going to have high-end photography equipment such as cameras, lenses, reflectors, and lights. These are things that are really specific to this person’s business. Someone with a construction company isn’t going to have an entire indoor photography set up the way that a photographer would.
One really good rule of thumb is that if someone hasn’t heard of it outside of your industry it’s probably an industry-specific deduction. The main thing here is that it needs to connect to your industry and the work you do.
This is also where people start to get a wee bit overzealous and claim deductions that aren’t specific to their industries by rather just something they want to write off.
Unless you have something that really relates to your business, don’t try to write it off. If it’s not related to your business, it’s a personal expense. Remember, that $200 you’re writing off isn’t worth what could happen to you if you get in trouble with the tax man.
Here’s how you’ll track these.
The first thing you’re going to do is you are going to pay for these expenses out of your business account just like you’d do with your ordinary expenses. Just like ordinary deductions, these are just regular business expenses. You don’t need to do anything special when you pay for them. You’re just going to use your business card. But there are a few other things that need to happen here.
When you have industry-specific deductions, create some kind of category in your bookkeeping program that really points to the fact that there are industry specific.
For example, a photographer would have photography equipment and supplies. A sewing business would have sewing equipment and supplies and then you can subcategory out for your own tracking purposes.
Sometimes you may have multiple industry-specific categories- which is totally fine! The main idea here is that you’re breaking out those industry-specific expenses from those regular business expenses. Don’t just put your sewing machine under office expenses or office supplies because that’s not what it is. It’s an expense for your industry.
Split Deductions (19:57)
Now it’s time for split deductions! Split deductions is honestly where people start to get a little bit confused about the tracking side of things. Split deductions are business expenses that are split between your business and your personal expenses.
Home office is a perfect example of a split deduction because part of your home is your personal living space and part of your home is your business space. For example, if you pay $2,000/month and 25% of that is your home office, then $1,500 is personal and $500 is business. It can feel a little bit confusing but these are exactly what I call split expenses.
Another example is a percentage of your cell phone. We all have these nifty cell phones that we answer e-mails on and a percentage of your cell phone use is personal and a percentage is business. Your home Internet is another example.
So we have all these examples of these expenses where we blend our business and our personal life.
Holy crap, how do you keep track of this stuff?!
First, keep track them on an ongoing basis. It can be really overwhelming, especially at tax time, if you haven’t tracked your split expenses all year! Generally, you will track your split expenses outside of your bookkeeping program because split expenses are usually paid out of your personal accounts.
Remember, you want to be doing this on an ongoing basis because going back for 12 months looking at old utility bills is pretty much the most unfun thing you can imagine.
Here’s a monthly tracking best practice.
First, set up a regular time to log your expenses on a monthly basis. Then, calculate your percentages because, remember, with split deductions you’re not writing off 100%.
SO- before you even get into tracking, set yourself up for success by figuring out your percentages. Figure out your home office percentage, your cell phone percentage, and your home internet percentage. These are the types of things that you would talk to a tax preparer about in terms of how to figure out your percentages.
Then, use a piece of paper or a spreadsheet to keep track of all of those split expenses.
Even if you feel lost and confused, just put down what you paid that month. Put down your total utility bill that month if you’re taking home office. Put down your rent or mortgage that month. Put down your cell phone bill.
If you don’t want to do the percentage stuff yet because you’re scared or worried, enter in the at the full price that you paid. That way, you’ll have that information handy and can relay it to your tax preparer. From here all you’ll need to do is keep up with it on a monthly basis.
Keeping up with tracking this on a monthly basis will keep your information updated throughout the year. Split expenses are the ones that slip through the cracks because it all the details can feel overwhelming.
Per the ushe- I’ve got a sweet little piece of business finance heaven for you. I have a cheat sheet with the most common tax deductions for small business owners. Remember, this post does not cover every deduction that I cover in my Bad Ass Business Finance course but I’d like to give you a cheat sheet to help.
The best way to use this PDF is to print it out. Go through all of the deduction categories listed. Some of them will not apply to you. Highlight the ones that apply to your business. Once you have your cheat sheet with the highlighted deduction categories, transfer that into another document. Use this cheat sheet when you do your bookkeeping and it’ll be a whole lot easier for you to categorize your deductions! I hope you enjoy it!