Ah, the shadowy mystery land of deductions- you know you need to go there but are worried about getting lost on the way. So many fears arise for folks when it comes to deductions: not knowing when to write something off, worrying about writing off the wrong thing, not understanding what expenses go where.
Have no fear, my friends! With a few quick steps, you can develop your own Deduction Roadmap that will guide you on your business journey. Be sure to download the free worksheet, which will easily walk you through each of these steps.
A quick note- this post is meant for educational and informational purposes and is not tax, legal, or financial advice. Always consult your tax professional before filing your taxes.
Ready? Let’s get started!
DevelopING Your Deduction Roadmap
Know what a deduction is
The first step to figuring out your deductions is to actually know what a deduction is! A deduction is a fancy way of saying business expense. A tax deduction is not just any expense- it is a business expense. It is the cost of you, the owner, of running and maintaining you business.
Deductions are important because, at tax time, they are deducted (get it?) from your gross income and reduce your taxable income. Deductions are also called write offs.
Look at Your Tax Return
Now that you know what a deduction is, it’s time to look at your tax return and see what deductions you’re already taking. You may be familiar with this or you may just be giving your tax professional a box of receipts every year. In either case, look at your Schedule C (usually the third page of your return) and go to Part II. Notice all the categories in which you have taken a deduction.
Are they what you expected? Are there any surprises?
Some of the lines items in this part may seem confusing. Most notably are depletion, depreciation, employee benefit programs, and pension and profit sharing plans. Most of these won’t apply to you, but if you see numbers on those lines, talk to your tax person about how they are calculated.
You may notice that there is a line (27a) that is called Other Expenses. These are deductions that are specific to your business and don’t fit into the standard categories. Go ahead and check these out too, they are in Part V of the next page.
Need more details on each of these categories? Check out my post on the The Epic Cheat Sheet to Deductions for Self-Employed Rockstars.
Make a List of Your Deduction Categories & What Goes In Them
Use your Schedule C to make a list of all your deduction categories (or use the list in the free worksheet). Next to each category, write down what expenses are part of this category. It’s super helpful to have your bank or credit card statement with you when you do this. That way you can go through each expense and assign it to a category.
Still confused? Let’s use Advertising & Promotion as an example. Going through my bank statement I see Mail Chimp (email marketing), Go Daddy (domain name registration- website), Blue Host (web hosting- website), and Moo.com (business card printing). All of these items would go under Advertising & Promotion.
Go Through Your Personal Statements & Look for Missed Deductions
This is a super important step! Using your deduction list, carefully look through your personal statements and see where you may be missing deductions. Often these are companies that store your card information and you haven’t updated them with your business card. iTunes (if your are buying business apps and software) and Amazon are the biggest culprits.
Also, be sure to check for any bills you pay that may be for mixed personal and business. Do you use your cell phone for business purposes (hint- you probably do)? Did you know you can write off a percentage of your phone bill based on how much you use it for business? That’s a missed deduction.
As you go through your personal statements make a note of all business deductions and, if they are mixed use, the percentage that you will deduct (the worksheet has a handy dandy chart to keep track of this).
Ask Yourself Three Important Questions
If you’ve gone through these steps then at this point you have a handle on what deductions you are already taking. But what about new expenses? How do you know if they are deductible? Here are three questions to ask yourself:
Does this expense have anything to do with my business?
Obviously the right answer is yes. If it’s no, it’s not a business deduction.
What does it have to do with my business?
Think this through. How is it connected to your business? You should be able to fully describe how the expense benefits your business. Pretend you are talking to Ron, our imaginary IRS auditor. Ron’s a pretty nice guy and here to listen but also wants straight answers. If Ron asked you about this expense, what would you say? Would Ron believe you?
Would you be spending this money if it weren’t for your business?
Generally if the answer is yes, you shouldn’t deduct it- or at least not fully (see the cell phone example above).
Let’s look at this a little closer. You take a taxi to a business meeting. You wouldn’t be taking that taxi if it weren’t for the business meeting- it’s deductible. You get a haircut to look good for business meeting. You would still eventually get a haircut, regardless of the meeting. It’s not deductible.
Page 4 of the worksheet walks you through these questions. I highly recommend you write through at least one expense in each of your deduction categories. It may seem silly, but actually going through these questions in writing will help you develop the “write off muscle” of your brain.
Now a quick disclaimer- every business is different and it is impossible to write a post that encompasses the nuances of each business. This post is meant to be a starting point and not legal or tax advice. If you have specific questions about your business I always recommend you consult a tax professional.
What’s the most important thing you learned about your deductions? How can you use your Deduction Roadmap to strengthen your business finances? How can you use your Deduction Roadmap to deepen your money relationship?
Understand Your Deductions
Get the free 4-page worksheet and develop your personal Deduction Roadmap.