We interrupt our regularly scheduled programming to bring you an overview on Business Expenses! If you find this post valuable – all thanks go to Courtney for submitting the question!
First of all, if you have business expenses PLEASE make sure you are paid on a 1099 (self-employed) or have set up an LLC through which you can deduct your expenses. Under the new tax law passed by the Trump administration at the end of 2017, this is really the only way to deduct those expenses. The entire “Job & miscellaneous deductions” section of the schedule A has been completely eliminated.
Secondly, there is a business income deduction for small pass-through entities. Most businesses qualify and although certain service businesses (attorneys, accountants, financial advisors, etc.) have an income phase-out, it generally works out beneficially for taxpayers with small businesses. You get an additional 20% deduction on your taxes due, on top of the new lower tax brackets!
Now the fun stuff!
What kinds of expenses can you deduct? Some common ones:
- Marketing expenses
- Home office expenses
- Cost of Goods Sold
The cost of products or raw materials, including freight
Direct labor costs (including contributions to pensions or annuity plans) for workers who produce the products
- Capital Expenses
- Business start-up costs
- Business assets
- Business improvements
- Business car expenses
- Business cell phone/utility expenses
- Insurance costs
- Retirement plan costs
- Training/Education Expenses
I want to touch on that last one because I think it’s extra important!
If you’re self-employed you can absolutely set up your own 401(k) plan or Self Employed Pension plan. This will allow you to stash more of your income away on a tax deferred basis. There are annual limits, of course, but it’s a great way to reduce your tax burden and save extra for the future. I encourage all my small business clients to establish 401(k)’s for their business, it’s basically forced savings for yourself that will pay you in dividends in the future.
I’m going to use a yoga instructor as an example here of a walk through of how you can significantly reduce the taxes you pay by utilizing expenses! Please make sure you track them and have receipts for proof. Unfortunately, those who have business deductions are statistically more likely to get audited – so don’t go writing off private jet purchases!
Let’s assume a yoga instructor has an income of $100,000 a year (and files as a single tax payer):
- Income: $100,000
- SEP IRA or 401(k) savings: $5,500
- Adjusted Gross Income: $94,500
- Marketing: $2,500
- Health Plan: $8,000
- Insurance: $2,000
- Yoga Mats: $300
- Blocks/Straps/Tools: $300
- Cost of Essential Oils for sale: $500
- Car Expenses: $4,500
- Gas/Mileage Expense (54.5 cents per mile): $400
- Music/ Subscriptions: $150
- Training/Education/Continuing Ed: $3,000
- Professional Memberships (Yoga Alliance, etc): $300
- Mandatory subscriptions to maintain licenses: $240
- Yoga apparel for teaching classes: $1,500
- Total Deductible Expenses: $23,690
- Taxable Income: $70,810
- Under the new tax brackets Federal Tax Due: $13,356.25
- WITH 20% Deduction: $10,685
Under the new tax bill your effective tax rate (not counting state taxes) would be only 15%. If you had a 401(k) and managed to stash away $18,000 (current cap for those under age 50) you could decrease it even more!
Of course, this is all used for illustrative purposes and should absolutely NOT be construed as tax advice. I’m not a CPA or an EA. Just a CFP® hoping to help make things simpler and easier for all!