With tax season finally over, now seems like a good time to talk about how to make next year’s taxes go as smoothly as possible. I especially want to focus on the self-employed and contractors. While there are all kinds of variables that complicate tax-filing (owning a home, dependents, interest income, divorce, marriage, death), many of us still work for corporations where we file a W-2 and our withholdings become automatic. For entrepreneurs, or people in more less formal income situations, it can be a bit trickier.
You Might Not Know…
If you’re just starting your own business, there are a few important things you need to know. Carson City Certified Accountant Michael Bertrand of Bertrand and Associates, LLC, tells me that a lot of small businesses don’t understand that they have to pay a self-employment tax in addition to their income tax. This tax is 15.3% of your net income, although you are allowed a deduction for the tax which reduces the rate. You need to understand what your income tax is, as well as the self-employment tax, and set aside money all year long to pay these.
Understanding What’s Deductible
What you can and can’t deduct gets complicated, but there are a few basic guides to help you understand it. In general, anything that is directly related (and some things that are indirectly related) to running your business can be deducted.
Meals and entertainment: Save all your receipts for taking clients to an Aces game, dinner, or golf. Keep in mind that you only get a 50% deduction for these expenses. Bertrand also pointed out that an audit will deny these deductions unless they include a record of who you talked to, and what matter relating to business was discussed. This doesn’t have to be exhaustive, just a note on the receipt will suffice. “So if you took a client to lunch at Red’s, you might want to note on the receipt ‘talked to Joe about potential new business,’” he said.
Travel Expenses: Okay, bear with me here, this one can be confusing. Business travel expenses can be deducted, but personal travel and commuting travel cannot. What that means is that if you have an office away from home, the miles from home to your office don’t count. If you don’t have an office anywhere, it gets a little weirder.
“If a woman owns a pet-care business, when she goes from home to the first customer’s house, that’s not deductible.” Bertrand said. You can consider that as being the commute from home to your place of work. “But say after that, she visits a few more customers, maybe stops at the pet store to get some supplies… that’s all deductible. But from the last stop to home is not deductible.”
Fortunately, there’s a way to simplify this process. It’s called…
Home Office: Having a space in your home dedicated as an office benefits you in multiple ways. First, you get a deduction on your rent/mortgage/utilities for that space, although it’s usually pretty small. What’s more important is that this eliminates the commuting confusion. “If you’re working from your home office, you now have a place of business, so when you leave your home, you’re leaving work,” Bertrand said. Suddenly the pet-care lady’s first customer is deductible after all.
Equipment: When you purchase equipment that lasts longer than a year (like a computer), it has to be treated separately from normal expenses and depreciated over time. However, Bertrand says there are accelerated depreciation methods whereby you may be able to deduct the whole amount in the year of purchase. Even your cell phone bill can be deducted if you use it for business, even if it’s used partially for personal purposes (which has not always been true).
According to SuperMoney’s Brenda Harjala, the way you think about your expenses and purchases has to change once you’re self-employed. “Here’s a general, but not foolproof, question for saving a receipt: Would you have bought that if you weren’t self employed?” she said, in a great guest post for Debt Roundup. “Would you have bought that Starbucks latte if you weren’t using their free Wi-Fi to work, or meeting a client? Would you have ordered new business cards if you weren’t planning to use them for your business?”
How/When to Keep Track
This is the main reason we’re talking about this in July instead of next March. You need to get into the habit of keeping daily records now instead of trying to round everything up at the end of the year, or even at the end of the month. Bertrand recommends keeping a daily log of your business miles, as the IRS doesn’t count an end-of-month summary as a written log. Your mileage won’t necessarily get denied if you don’t log it daily, but it’s certainly a best practice to do so. It doesn’t have to be too detailed. As soon as you arrive at your client meeting, pull out your little mileage notebook and write “July 11 - 3 miles, client meeting”.
There are different recommendations for how to keep your receipts. I think the important thing is that you don’t keep and store them in 15 different places. Keep a file drawer at your office with folders separated by type, and get in the habit of depositing receipts there daily.
Personal Finance Management Tools
The key to having immaculate records at the end of the year is having clean records throughout the year. Thanks to our brilliant technological advances, there are lots of online tools like Mint.com and Clearcheckbook.com, or software like AceMoney or Quicken, that make it easy to track income and expenses, separate different types of accounts, and place expenses in categories.
Talk to the experts
I sincerely hope this blog has been helpful in highlighting some of the habits that will make your self-employment life easier. Nevertheless, we highly encourage you to always talk to a tax practitioner about your specific situation.