Tax-deductible items for the self-employed
When you start your own business, you accept a lot of responsibilities. Some of them, like self-employment taxes, might be more than you expected. Of course, being self-employed can also be very rewarding.
One of the bright spots is the ability to deduct business expenses from your income to save on taxes. But, there are very strict guidelines that determine which expenses are tax-deductible items for the self-employed.
General Deduction Requirements
There are two general conditions that must be met for an expense to be deductible. First, an expense must be ordinary; it must be the type of expense that is common and accepted in your particular industry. Second, it must be necessary.
This does not mean it is indispensable and that your business would fail without it.
But it cannot be frivolous, it must be actually helpful. But, given these requirements, deductible expenses also do not include costs of goods sold, capital expenses or personal expenses.
Capital expenses cannot be deducted by the self-employed. Capital expenses are investments in the company itself.
For example, the purchase of a car or a copy machine that get ongoing use cannot be deducted. Similar improvements to the business are also capital expenses.
The value of the machine can be gradually reimbursed through depreciation of the asset. Repair or maintenance of the car or copier, however, can be deducted.
Cost of Goods Sold
Though legitimate business expenses can be deducted, you cannot deduct the cost of materials that go into items you subsequently sell.
Other costs related to manufactured products that cannot be deducted because they are incorporated into the cost of goods sold include transportation costs, storage, labour and factory overhead.
Basically, any expense that goes into the cost portion of your wholesale or resale price is not deductible. Instead, these expenses are deducted from gross receipts to calculate your profits. However, transportation, storage, labour and other costs that do not directly contribute to the cost of a good or service sold can generally be deducted.
Personal Versus Business Expenses
If you are self-employed, though, most of your tax deduction issues probably revolve around the difference between business and personal expenses. Expenses that are exclusively personal, living or family expenses usually cannot be deducted.
The exception is when you have expenses that are partly business and partly personal. This frequently occurs when you use a portion of your home as an office, or use a phone line for both purposes. The general rule is that the per cent of the total expense that is used for business purposes can be deducted. In the case of rent or mortgage payments, the per cent of your total square footage represented by your office space is the same per cent of your rent or mortgage you can deduct as a business expense.
Clothing is an exception to the exception. If the clothes you wear for business purposes are clothes you can generally wear for non-business purposes, the cost of the clothing cannot be deducted at all. This excludes most office professional ware.
But, if the clothing is a specifically suited to a business purpose, like a unique uniform, it can be deducted. Clothing that has a company logo, design or colours is usually deductible because most people will not wear these apart from work.
Medical and dental insurance premiums are another expense that are treated differently from other expenses.
If you are covered by an unsubsidized employment plan, medical insurance premiums for you, your employees and dependents of you and your employees are 100 per cent deductible. But, if you are self-employed and your spouse is covered by a company in which you would be eligible for coverage, you cannot deduct your own medical insurance premiums.
Other occasional medical expenses, like doctor visits and prescriptions are available as itemised deductions if they exceed 7.5 per cent of your adjusted gross income. For more details, see the Additional Resources section below.