Small businesses have their own set of tax regulations and requirements. Some small business owners may find themselves paying more taxes than they did when they worked as an employee within an organization or other business.
One of the challenges you’ll face as a freelancer or small business owner is accurately accounting for and deducting business expenses.
Generally, the IRS requires that the expenses in question be “ordinary and necessary.” In other words, they must be typical expenses for your type of business and must be necessary for your business to be successful.
Understanding the Difference Between Personal and Business Expenses
If you use cash and resources for both personal and business use, you will need to accurately record the percentage of business and personal use. One of the most common deductions is for vehicle use.
If you use your vehicle for business purposes 80% of the time and 20% for personal use, you can deduct 80% of the overall expenses (such as fuel, oil, repairs,) as a business expense.
However, the IRS looks very closely at this small business expense, so it is vital that you maintain accurate records of personal and business vehicle use and expenses. Keep all receipts related to repairs, fuel, and maintenance in case the IRS does come calling in the form of an audit. Better to have too much supporting documentation than not enough documentation.
Calculating Cost of Goods Sold
If your business is centered on creating a product and maintaining inventory, then you will need to calculate the Cost of Goods Sold (COGS) before writing off business expenses.
Take into consideration the cost of raw goods used in manufacturing your product, along with storage fees, labor costs, and overhead expenses from the factory. Once you calculate your COGS, you can accurately place a value on any remaining inventory at year end.
One word of caution: if a business expense was included in the COGS, you can’t write off that business expense as a deduction.
Running your own business has its share of joys and headaches. By understanding a qualified business expense and understanding the difference between business and personal expenses, you can save yourself the additional headache of inaccurate business records and the possibility of an IRS audit of those same records.
If this is your first year in business or if you need help understanding the tax codes related to small business, don’t hesitate to get in touch with a qualified tax advisor. He or she can walk you through IRS regulations as they apply to your business and provide guidance should you ever be faced with an IRS audit.
As a small business owner, you may find yourself facing additional expenses, but you can’t put a price tag on the peace of mind you’ll get when consulting with a knowledgeable tax pro.