Tax deductions are valid business expenses that you claim on your taxes. Claiming deductions saves you money by reducing your taxable income so you pay less in taxes to Uncle Sam and your friends over at the IRS. The best part is that you are probably already paying for these expenses…you just need the right information to turn them into valid tax deductions.
However, there are common mistakes when it comes to small business owners deducting items the IRS does not allow for. Here are three common expenses that should be carefully considered before you add them to your Profit and Loss Statement:
Clothing:
Overview
This is especially tempting for people in the Real Estate field. They typically dress well and drive nice vehicles to impress clients. However, the IRS takes exception to deducting fashionable clothing. The allowance for clothing deductions has a very narrow scope and only includes items that would be considered uniforms or protective clothing.
Criteria:
- It is essential for your business;
- It is not suitable for ordinary street wear; and
- You don’t wear the clothing outside of business.
What is deductible:
- Cost of uniforms or special work clothes not suitable for personal wear
- Cost of dry cleaning and other care
What to collect:
- Name of vendor
- Amount
- Date
- What you used to pay for the expense
Gotchas
If you can wear it on the street and could be considered part of an everyday outfit, the cost is not deductible. Unfortunately, the IRS thinks you can wear almost anything around town.
Case: A musician in Rod Stewart’s band was denied a deduction for most of his stage wardrobe, including silk boxers, leather pants, hats and vests, but was allowed a deduction for several items that the courts felt were too gaudy for ordinary wear.
Tip: The costs of cleaning your clothing while on a business trip is an exception. You may deduct the cost of cleaning all of your clothing while on a business trip and you may deduct your first laundry bill for clothing used on your business trip when you return.
Communication:
Overview
As a business owner, you absolutely need methods of communicating with customers, vendors and colleagues. But, the IRS closely reviews these deductions, so make sure you are only deducting the portion used for business.
Criteria:
- Ordinary and necessary:
- An expense is ordinary if it’s common to your profession. A necessary expense is one that’s appropriate or helpful in developing or maintaining your business.
- Current expense: will benefit your business for less than one year
- Directly related to your business: not personal
- Reasonable in amount: reasonableness is dependent on the circumstances and not limited to a specific dollar amount
What is deductible:
- Internet access fees
- Phone expenses
- Cell phone expenses (see gotchas)
What to collect:
- Name of vendor
- Date
- Amount of expense
- What you used to pay for the expense
Gotchas:
- Allocation of use may be necessary for cell phone and internet expenses that may be used for both personal and business purposes.
- Don’t write off 100% of your cell or ISP charges if you use them for both business and personal purposes.
Tip: Save 3 months of your cell phone records and use them to establish the percentage of business vs. personal use.
Transportation:
Criteria
- Ordinary and necessary: An expense is ordinary if it’s common to your profession. A necessary expense is one that’s appropriate or helpful in developing or maintaining your business.
- Current expense: will benefit your business for less than one year
- Directly related to your business: not personal
- Reasonable in amount: reasonableness is dependent on the circumstances and not limited to a specific dollar amount
- Travel that is not overnight and that is in your local area
What is deductible
Vehicle expenses
- 2 methods for calculating expenses
- Standard mileage – Multiply business miles by a per-mile rate set by the IRS.
- Actual expense – Multiply total auto expenses by the percent of business use.
- Tolls
- Parking
- Taxis
- Public transportation costs
What to collect (non-auto expenses):
- Name of vendor
- Date
- Amount of expense
- What you used to pay for the expense
What to collect (auto expenses):
- If using the standard mileage deduction – collect mileage information
- If using the actual expense deduction – collect the same information as non-auto expenses
Gotchas
- Commuting costs to your normal place of business are not deductible.
- Home office: If your principal place of business is a home office, you can deduct the cost of any trips made to another location for business. The commuting rule does not apply.
- If you have no regular place of business, you can’t take this deduction.
- The cost of meals and lodging for local transportation are not deductible
- Transportation expenses are one of the first things the IRS looks at when analyzing a business tax return.
Tip: Establish a “regular place of business” so you can write off any transportation to other work sites.
Feel free to give us a call and ask how you can ensure all of your deductions are properly categorized.