The complete guide to small business tax season

So many small business owners dread tax season. Not only does it mean extra work on your plate, the fear of getting audited if you make a mistake is really stressful.

But there’s a different way to think about tax season. All the extra work you’re doing at this time of year can actually teach you a lot about your business, and help you plan better for the year to come.

tax season

We built this guide to help you with three key things that will reduce your stress and give you insight into your business:

  • To help you prepare your books properly for your accountant so that they can help you save as much money as possible.
  • To demystify audits so you can prevent them, handle them when they happen, and stop fearing them.
  • To teach you how to stay on top of your books year-round, so you won’t procrastinate and panic at tax time anymore.

Tips for keeping your books organized

Understanding common tax deductions that save you money

Tax season can be stressful—especially for small businesses. But it’s also a huge opportunity for entrepreneurs to dig deep into their business’ finances and performance and set yourself up for success in the coming year.

Business tax deductions are a big part of that because they can save valuable funds you can reinvest to grow your business. According to the United States Internal Revenue Service (IRS), business tax deductions for 2015 totaled over $1.1 trillion. That’s one big opportunity.

How do tax deductions work?

In a nutshell, tax deductions (also called write-offs) are one way taxpayers can lower their tax liability or the amount of tax they pay. When you prepare and file your taxes, you claim the deductions your business qualifies for on your annual tax return.

Deductions come in all varieties, but they have one thing in common—they count against and reduce your total taxable income. That’s different from a tax credit, which counts dollar-for-dollar against your tax liability for the year.

For example, if your business income for last year was $100,000 and you claim $20,000 in write-offs, your taxable income is $80,000. Your savings from those deductions are the total deduction amount ($20,000) multiplied by the tax rate for your income bracket. If your rate is 25%, for example, those deductions would save you $5,000 on your taxes for that year.

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Deductions for self-employed workers

Independent contractors, freelancers, and sole proprietors are all considered self-employed workers in the eyes of the IRS.

What does that mean? At the most basic level, being self-employed means you don’t report to someone above you. From a tax perspective, self-employed workers typically pay quarterly estimated taxes that cover income tax and the additional self-employment tax.

For an individual, those taxes can add up in a hurry. That’s why it’s important to understand the six deductions we’ll cover next—so you can be ready to claim them and lessen the burden once tax seasons rolls around.

1. Home office deduction

The home office tax deduction is probably one of the most well-known and least understood deductions available to self-employed people. In a nutshell, this deduction is aimed at giving you credit for expenses associated with maintaining an office in your home.

It can be a substantial annual deduction, so it’s a wonder why more self-employed workers don’t claim it.

Previously, home office deductions were less common, making them somewhat of a lightning rod for IRS audits. But as remote work and the gig economy has grown, home office deductions have become more routine for the IRS—meaning the threat of an audit has dropped off substantially.

The costs of maintaining a workspace in your home can really add up, so if you’re eligible, the home office deduction is well-worth the time spent calculating it. You can deduct a percentage of home office expenses relating to:

  • Rent or mortgage
  • Renters’ or homeowners’ insurance
  • Property taxes
  • Internet and utilities
  • Leasehold Improvements

Not to mention, beginning in the 2013 tax year, the IRS instituted a standard rate for home office deductions, creating a much faster and simpler method for calculating your deduction amount. The rate for 2017 was $5 per square foot of office space.

Your home office space only needs to meet two main requirements to qualify for the deduction:

  1. The space has to be used to conduct business regularly and exclusively, meaning you can’t claim an entire room if it actually doubles as the guest room.
  2. Your home office needs to be your primary place of business. If you head to the coffee shop from time to time, that’s okay. But if you rent a desk in a coworking space for 25 days out of the month, your case for the deduction is a little weaker.

If you rent an office space outside your home, see the Rent and utilities section under small business deductions.

2. Legal and professional fees

There are some aspects of running a business that are better handled by experts. When you work with a professional to handle something (like an accountant to file your taxes or a lawyer to incorporate your business), you can deduct the cost of their help.

The deduction includes professionals of every stripe, including:

  • Lawyers
  • Accountants
  • Bookkeepers
  • Consultants
  • Independent contractors
  • Appraisers
  • Systems analysts

It’s important to note: you can only deduct professional fees that are directly related to your business. For example, if you hire an accountant to file both your personal and business taxes, you can deduct only the cost of your business tax filing.

3. Your own benefits

For some self-employed workers, health insurance, retirement savings, and other benefits you’d otherwise receive from an employer can easily become your biggest expenses. That’s why are also typically eligible as deductions from your taxes. The most significant (and frequently evolving) deduction is for health insurance premiums.

You can deduct all premiums for health, dental, and long-term care insurance for you, your spouse, and any dependent children under 26 years old. Most self-employed workers are eligible, but you may not qualify if:

  • You or your spouse were eligible for an employer-provided health insurance plan
  • Your business income for the year was less than your health insurance premiums (if you reported a net loss).

In addition to health insurance and retirement contributions, you can also deduct other common types of insurance you may need as a solopreneur—including professional liability insurance, disability insurance, and home-based business insurance.

4. Business-related education

If you pursue additional education to either maintain or improve skills that relate directly to your business or your legal ability to continue in the field, you may be able to deduct the cost of that education.

For example, an SEO consultant can deduct the cost of a course on what’s new for SEO in 2018. The IRS Publication 970 offers more guidance on expenses that do and do not qualify. However, this deduction is one that gets pretty specific, so we recommend working with a tax professional to see if you’re eligible.

For self-employed workers, the education deduction actually lowers your taxable income (instead of being credited against your tax liability), so it’s well-worth taking if your expenses qualify.

Note: All taxpayers are also eligible to deduct any interest paid against your student loans. You should receive a 1098-T form from the lender, which includes the total interest you can deduct.

5. Travel

A family vacation to Maui unfortunately does not qualify for a business tax deduction. But any travel you do to meet with or acquire clients, perform services or deliver products, and attend conferences, seminars, and other education or networking events is a deductible travel expense.

Business travel has to be reasonably and demonstrably related to your business, of course, and you can write off all expenses including:

  • Transportation (airfare, train fare, bus fare, Uber/Lyft/taxi fare, rental car, and auto mileage)Travel by airplane, train, bus or car between your home and your business destination.
  • Fares for taxis or other types of transportation between the airport or train station and your hotel, the hotel and the work location, and from one customer to another, or from one place of business to another.
  • Using your car while at your business destination. You can deduct actual expenses or the standard mileage rate, as well as business-related tolls and parking fees. If you rent a car, you can deduct only the business-use portion for the expenses.
  • Meals and lodging.
  • Accommodations (hotel or Airbnb)
  • Meals and entertainment for clients or customers

The key to appropriately deducting business travel expenses is to be reasonable. The IRS is vigilant about ensuring your deductions are legitimate business necessities. That means indulging in first class airfare or trying to deduct a 10-day family vacation where you met with 1 client won’t fly.

Keep accurate and plentiful records and use a degree of reasonableness, and your deductions won’t raise any red flags.

6. Merchant processing and service fees

Self-employment means you’re accepting payments from clients or customers. Depending on the payment methods you accept—and the tools you use to process them—you’re responsible for merchant processing and service fees on those payments.

For example, typical credit card processors charge between 2.5% – 4% of the transaction amount. Those fees can definitely add up throughout the year, so it’s important to keep a record of every transaction. Those records enable you to deduct merchant processing fees from your business income.

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Deductions for small businesses

Small businesses represent the vast majority of firms in the United States. They drive job creation and economic growth—they also contribute a lot to annual tax revenue.

Because small business and entrepreneurship is such a vital part of our economy, there are several tax deductions that can help lessen the burden on small businesses. In fact, many different business expenses can be deducted from your business taxes, including rent and utilities for your office and even invoices and bills that go unpaid.

1. Rent and utilities

Whether you rent a physical office space for 50 or one desk in the coworking space downtown, both your rent and any utilities for the office are deductible business expenses. Utilities include: electricity, gas, water, telephone, and internet bills.

If you work out of your home you can still deduct some of these expenses as they relate to your business use of the space. See the Home office deduction section above for more.

2. Equipment

Running a business involves a lot of equipment—even if it’s just you and your partner. Luckily, you can deduct almost any equipment your business requires, including:

  • Computers and laptops
  • Printers, copiers, and fax machines
  • Desks, filing cabinets, and other office supplies like paper, pens, and Post-It notes
  • Software
  • Vehicles
  • Any specialized equipment unique to your industry (like a heat press machine for a company that sells novelty t-shirts)

For the bigger ticket equipment, you can choose to deduct the full value in the same year you buy it or spread the cost out over a number of years (depending on the type of item).

3. Employee salaries, wages, and benefits

Self-employed workers can deduct their own benefit and insurance premiums, and the same applies to small business owners. If you have employees, you can also deduct their salaries (including wages and bonuses) and any benefits you provide to them and their families.

In addition to full-time employees, you can also deduct costs and fees that arise from working with other business professionals and contractors, including:

  • Lawyers
  • Accountants
  • Bookkeepers
  • Consultants
  • Independent contractors
  • Appraisers
  • Systems analysts

It’s important to note: you can only deduct professional fees that are directly related to your business. For example, if you hire an accountant to file both your personal and business taxes, you can deduct only the cost of your business tax filing.

4. Advertising expenses

Marketing and advertising for a small business can include a whole, wide swatch of tactics—all of which can be deducted as advertising expenses for your business. If you’re drawing a blank, here are some of the most common advertising expenses for today’s small businesses:

  • Business cards
  • Branded swag (from pens to popsockets)
  • Website costs (including domain registration, site hosting, and design)
  • Digital advertising (like social media ads, paid content, and PPC ads)

Everything from business cards to Facebook ads to billboards counts toward this deduction, so be sure to keep records on all your advertising expenses throughout the year.

5. Business insurance

As your small business grows, there are several different types of insurance you’ll need—from professional liability insurance to workers’ compensation and product liability insurance. The premiums for any insurance policies your business needs are deductible, similar to your health insurance deductible.

6. Bad debts

In any business, you have to account for some customers or clients who simply won’t make good on promises to pay. While you can’t magically make everyone pay their bills, the good news is you can deduct bad debts from your annual business taxes. Here’s what the IRS considers eligible for the bad debts deduction:

  • Money you’ve loaned to other businesses, employees, or vendors
  • Unpaid purchases of goods and services

Common mistakes to avoid when you deduct business expenses

Understanding the tax deductions that are available to you and your business is the first step in winning the year-end season. When you make the most of the deductions you qualify for, you’re lowering your tax burden and saving money—money you can put right back into your business (or money you can use to fund a little break from your business).

But there are a few common mistakes both self-employed workers and small businesses fall into, and they can end up costing you. Here are some of the mistakes we see with tax deductions—keep them in mind so you can avoid falling into these traps.

Failing to document and record

No matter which business tax deductions you claim on your taxes, they all have one thing in common: you need proof.

Deductions can be lucrative, so there are always people who erroneously claim tax credits and deductions they don’t qualify for. If your business is audited by the IRS, you’ll need documentation to back up every deduction you claim. That’s why it’s absolutely vital that you always document and record all of your business’ expenses, especially those you claim on your tax return.

You file taxes once a year—which means you have to remember and keep track of documentation for a good while before it comes in handy. You have a lot on your plate, and we know it’s easy for invoices to disappear and receipts to fall through the cracks.

That’s why we always recommend having a system in place to organize and manage your expenses and receipts. If you’re already using Wave, you can upload and categorize receipts. You can also sync your business bank account to automatically import expenses.