Whether you are an investor, business owner or self-employed consultant, there are many benefits to working for yourself. One major upside involves tax advantages.
The two biggest things you’ll need to concern yourself with are expenses – both operating and capital.
Operating, or business, expenses are the costs of conducting a trade or business, and they are usually tax deductible. For example, the costs of renting an office, going on business trips and paying employees are all deductible expenses.Such expenses must be both “ordinary” and “necessary” in order for you to take the deduction.
Capital expenses, by contrast, are the costs of purchasing specific assets, such as property or equipment that usually has a working life of one year or more. If you, for example, purchase a computer or a car for business use, they could be considered capital expenses.
Such purchases do not qualify as business expenses, but you can still recover the money you spent on capital expenses through depreciation, amortization or depletion. These recovery methods allow you to deduct part of your cost each year so that you are able to recover your capital expenses over time.
Figuring out whether a purchase is a business expense or a capital expense is not always clear cut, so consult the IRS or an accountant for more detailed advice.
One big decision many small-business owners face is whether to claim part of your house as a home office. The key here is that the space must be devoted exclusively to your business. No other activities may routinely go on there, and the burden of proof is on you to demonstrate that. To figure the deduction, measure your work area and divide by the square footage of your home. That percentage is the fraction of your home-related business expenses — rent, mortgage, insurance, electricity, etc. — that you can claim.
You can also claim the cost of office furniture. If you choose to depreciate the desks and filing cabinets, you can’t simply split the cost into equal portions over the depreciation period. Instead, you must use an IRS chart to make separate calculations each year. Both options are reported on IRS Form 4562.
Also, travel is an attractive area in which business owners can find deductions. The entire cost of each business trip is tax deductible. That includes direct costs such as hotel and airfare, but also related costs such as dry cleaning, rental cars and even tips.
The only exception is eating out. You can deduct only 50 percent of your meals while traveling.
Another area to watch is health-insurance premiums. They are 100 percent deductible. However, they cannot exceed your business’s net profit, and the deduction is not allowed if you were eligible for other health-care coverage.