Are you self-employed? If so, how do you know which business expenses you can deduct?
Do you ever worry about raising a red flag on your tax return? It’s not always easy to determine which business expenses to write off.
Let’s review the different types of business expenses and how you can deduct the most for your business expenses.
Before we dig into the list of business expenses you can deduct, I’d like to review self-employment.
What is Self-Employment?
Who is self-employed? The IRS has three definitions for self-employment:
- You are the sole proprietor or an independent contractor in business for yourself.
- You are a partner in a business.
- You are otherwise in business for yourself (including a part-time business).
These are fairly self-explanatory. Basically, if you own a business, are a private contractor, or are in some other way in business for yourself, you are self-employed, and are subject to self-employment tax requirements.
Which Business Expenses Can You Write-off?
One of the major points of confusion in determining tax obligation is expenses: What are they and which do you qualify to write-off?
Expenses are products or services on which a business spends money. Tax-deductible business expenses can help reduce what you owe in taxes.
To be deductible, a business expense must be necessary for the operation of the business. These are called ordinary and necessary expenses. The goods and services associated with these expenses are commonly accepted items in your trade or business that are helpful and appropriate for your business. There are many forms of expenses, and the two major expense categories are capital and non-capital.
Types of Business Expenses
A capital expense occurs when a business buys a new asset. Usually, capital expenses require significant initial investment and can help focus on future growth. Because of this a capital expense is an asset and appears on the books as such. Oftentimes, there is a loan that coincides with the purchase of a capital asset. Capital assets usually have a useful life of more than 1 year.
Capital expenses can be tangible or intangible. An example of a tangible capital expense is large, expensive machinery. An example of an intangible capital expense would be costs associated with or the value of a patent, license, or trademark.
Capital expenses are not necessarily immediately deductible. In some cases, small capital expenditures may be eligible for immediate deduction using the Section 179 deduction or the allowable bonus depreciation. Intangible assets must be amortized over 15 years and do not allow for any special depreciation methods. Self-employed taxpayers should seek professional advice regarding which is most appropriate for their unique situation.
On the other hand, non-capital expenses are usually less expensive than capital expenses and have a useful life of less than 1 year. These expenses are required to maintain the business. This can include everything from rent to interest to insurance.
It is important to remember that unless a portion of the expense is used for the business, it cannot be deducted.
Deductible Business Expenses
The expenses here are listed in the order they appear on IRS Form 1040 Schedule C. If you are self-employed in a partnership, then a different tax return, Form 1065, is required vs. Schedule C. The deductions here are not an exhaustive list. Please consult a tax professional for any help with business expense write-offs.
Advertising & Promotion
I think all business owners advertise at some point to help generate new business and growth. Generally, you can deduct any form of advertising or promotion cost as long as it is for the sole benefit of your business. The IRS sees any form of promotion as a regular and necessary expense to conduct business.
Advertising or promotion can include Facebook ads, business cards, etc. Self-employed individuals who sponsor nonprofit organizations or events can deduct these costs as advertising and promotional expenses, as well. This is a great way to contribute to a cause you support and make it a deductible business expense.
Car & Truck Expenses
Self-employed individuals have two methods for deducting car and truck expenses: standard mileage rate or actual expenses.
Standard Mileage Rate
The standard mileage rate changes every year. You can easily find the current year’s rate if you do a quick search online. If you use the standard mileage rate, you can add the costs of tolls and parking to the total amount. Be sure to track miles carefully. I suggest using an app like MileIQ or keeping a very detailed mileage log including start/end mileage for the vehicle.
Actual Expenses Method
When tracking actual expenses for a vehicle used for business, make sure to keep good records for maintenance, repairs, fuel, insurance, registration costs, etc. Using actual expenses also allows you to take depreciation on the vehicle. This can be a helpful write-off. Be careful here though as autos have specific rules around depreciation.
Commissions & Fees
Commissions and fees are those payments made to others, not what you received. Self-employed individuals who paid others commissions, such as for a referral can deduct that expenses.
If you use independent contractors to help in your business, you can deduct the cost of their service. As with commissions and fees, self-employed individuals who paid an independent contractor $600 or more must file Form 1099-NEC to report the payments.
Contract labor does not include legal advice, wages paid to actual employees of the business, or any costs associated with the maintenance and repair of business property. All of those expenses are reported elsewhere.
Depreciation is a method to calculate the cost of a physical asset over its useful life. Basically, it is used to represent the amount of asset value that has been used within the tax year. You can generally only need to depreciate items that cost more than $2,500 including vehicles, real property, and other high-cost assets.
In some cases, depreciation is spread out over multiple years, and there are several methods to calculate depreciation. I would discuss taking depreciation with a tax professional to see how it can help reduce your taxes.
Sometimes, full depreciation can be taken in the year the asset was purchased using Section 179 deduction. This method only applies to assets with more than 50% use in the business.
Businesses generally need to carry insurance to protect themselves. The two types of insurance that are deductible in this category are liability coverage and errors and omissions coverage. All other insurance expenses—such as health, worker’s compensation insurance, or car/truck insurance—are deducted elsewhere.
Interest expenses can be complicated, and whether they’re deductible depends on the type of interest that the self-employed individual paid. Loan interest is deductible if the loan is securing business property. Credit card interest can sometimes be deductible, but the credit card must be used for business purposes. In some cases, deductibility must be allocated.
For example, if a self-employed person has a credit card that is used for both business and personal reasons, only the business portion of the interest could be considered deductible. This is one reason I stress keeping finances separate. No mingling of personal and business funds means it’s easy to determine what is and isn’t a business expense.
Legal and Professional Services
Professional services, specifically stated by the IRS as accountants and attorneys, are fully deductible if they help with your business. Remember that personal and business expenses must be kept separate just like all your business expenses. For example, if you hire a tax preparer for both your business and personal taxes, you must keep the costs separate.
Meals can be deducted in one of two ways. The easiest way to deduct meal costs while traveling is to use the standard meal allowance permitted. The IRS specifies the amount that can be deducted for meals and incidentals on a given day. For 2021, the rate is $66 per day but it can vary for more expensive locations and for travel outside the U.S.
The other method is to take actual expenses. For most people, only 50% of the actual cost of meals is deductible. Remember to keep ALL receipts for meals while traveling. These will be necessary records for taking this deduction. For 2021, the IRS has allowed this expense to be 100% deductible. Good for you if you travel or treat clients to meals in 2021.
This can sometimes be a confusing category. While you might think this category refers to paper, staplers, and other more traditional supplies. It actually refers to items that are necessary to run your office even if that office is mobile or remote. This can include software, phone, cloud hosting, etc. This can include small furniture, printers, etc. to help with the day-to-day running of your business.
Rent is deductible if it specifically applies to business. This can include renting office space. It can also include renting equipment necessary for your business. I’ve also seen rent for storage of business property count towards this category. Remember this is separate from your personal expenses and rent as a deductible expense must only be for business property.
Repairs & Maintenance
Like all the other business expenses, this is for repairing or maintaining your business property or equipment. This helps keep your business assets in normal working order. For example, you have a broken camera and pay someone $500 to repair it back to working order.
The general safe harbor is the same as all other deductible expenses set by the IRS. Anything under $2500 per invoice is usually accepted. It can also be under $10,000 total for a larger item or 2% of the basis of a larger asset. Any specific questions around this expense can be addressed with a tax professional.
For remote self-employed individuals, I don’t typically see assets that are too high in cost. While there is always an exception, it’s not common among digital nomads.
This is the cost of any supplies or materials to run your remote business. Examples include paper, toner, packaging for shipping, camera, small equipment, etc.
If you are ever having trouble making the distinction between what is considered deductible and what isn’t, remember that most things are deductible if they are regular and necessary. The IRS has three rules when it comes to allowing deductions for office supplies. You can generally deduct 100% of the cost if:
- You do not keep specific records of the use of office supplies.
- You do not track inventory for office supplies.
- The value of the deduction doesn’t reduce your income to a level significantly lower than it should be.
Taxes & Licenses
If your business is required to register with local, state, or federal authorities, then that cost goes here. It can include all licensing and permits necessary to legally operate your business. This can include a local business license, state registration costs, and any other permits necessary to keep your business safe and in compliance with the authorities.
This can also include any professional licenses that are necessary. You would include any state and local taxes here as well if they apply to you. If you collect sales tax from your customers and include it in your income, you can deduct it in this category.
Travel can be an important part of any business including those who are remote and self-employed. A trip is deductible if it considered business-related. For it to be deductible, the IRS stipulates that you are conducting business away from your tax home. Tax home has a whole new meaning for those that travel as a lifestyle. Learn about travel expenses when you travel full-time. It might not be as simple as you think.
Transportation and lodging are allowed for overnight trips. Only expenses for the self-employed individual are deductible, not the cost for a spouse or dependents to travel with the business owner. Transportation can include Uber, Lyft, rental cars, flights, etc. while lodging can include AirBnB, traditional hotels, VRBO, etc.
This is not usually something that many remote business owners are able to deduct since they won’t have traditional office space. However, this category includes electric, gas, business phone service, etc. If you have an extra phone line set aside for your business, then you might have something to deduct here.
Home Office Deduction
If you work from home AND have a 100% dedicated office space, then you might qualify to take a home office deduction. I recommend using the simplified method for claiming this deduction. This is calculated using the square footage of the home vs. the space that is exclusively used for business (limited to 300 square feet). You multiply that number by $5. Therefore, using this method limits the deduction to $1,500.
I don’t usually see this expense as allowed if you are a digital nomad or full-time RVer since there is no 100% dedicated office space. There are exceptions to this and I urge you to reach out to a tax professional to see if you qualify for this.
While all the above expenses have a specific line item on the Schedule C, there are other expenses that may be deductible by self-employed individuals. Let’s review some additional business expenses.
Training and Education
Continuing education is important for business growth. This can include professional development and attending conferences. It also includes books and training to further develop your knowledge as it related to your profession or business. This can also include education that is required to maintain a professional license.
These are normal expenses for running many businesses. This can include foreign transaction fees, account maintenance fees, wire fees, etc. Again, these must be business, not personal, expenses in order to be deductible.
Most people operating a business nowadays need to take payments and there is also almost always a cost to do so. Any merchant fees can be stated separately. Examples of merchant accounts include PayPal, Stripe, Quickbooks Merchant, and any other credit card or payment processor.
Health insurance costs, as well as costs for dental and long-term care insurance, are sometimes deductible for both the self-employed person and their spouse, dependents, and eligible adult children. If the self-employed person is eligible to participate in any other insurance plan, including one offered by their spouse’s employer, premiums are not deductible. There are other eligibility requirements and limitations, as well.
First, and most importantly, the self-employment business must actually make a profit. The amount of net profit determines the percentage of the premiums that can be deducted. Second, if you are purchasing long-term care insurance, you must also meet certain age requirements. Third, there are other exceptions that may allow deduction of health insurance premiums, but they can be complex, so it’s best to consult a tax professional to determine your eligibility.
Membership Dues & Subscriptions
If you own a business, the dues you pay to professional, business, or civic organizations are deductible expenses. Applicable organizations include trade associations and dues. Similarly, subscriptions to publications from professional organizations, such as trade magazines, professional journals, and similar, are deductible expenses. Any dues or subscriptions paid to an organization with the main purpose of entertaining its members are not tax-deductible.
1. What is the self-employment tax?
Everyone needs to pay Social Security and Medicare taxes if they earn money. If you are employed by someone else or another business, your employer typically pays part of these taxes. However, if you are a sole proprietor or independent contractor, you are both employer and employee, so you pay the full amount on what you earn via your business. This is the self-employment tax.
2. My business just started. How do I know if I need to pay self-employment taxes?
Anyone who earns at least $400 through self-employment must pay self-employment taxes. The only exceptions are some individuals employed by churches. Also, if your business does not earn a profit, you will not need to pay taxes. Paying self-employment taxes earns you credit towards Social Security or Medicare for that year.
3. How much should I expect to pay?
The self-employment tax rate is calculated at 15.3% of your net profit for the business (also called net income). Social Security accounts for 12.4% (it is capped, though), and Medicare accounts for 2.9%. Medicare can include an additional 0.9% for those with a higher income. If you have income from an employer as well as income from self-employment, both incomes are considered in determining your income tax obligation.
4. What income is included in the self-employment tax?
You will pay Social Security tax on the first $142,800 (2021 salary) of your earned income, which includes anything you earn as an employee in addition to any self-employment income. 100% of your self-employment income is subject to Medicare tax.