For many people who make the decision to be self-employed people, the line between work and personal life isn't always perfectly clear. This confusion often causes people to cheat themselves out of legitimate deductions. Make sure you are taking all the tax write offs you can, because a sound tax deduction strategy can save you from overpaying your taxes by thousands of dollars every year.
People who are self employed can often end up cheating themselves by considering an expense to be personal when it's really a business expense. In the corporate world, it's clear who is a business associate, and who isn't. For the self-employed, that line is isn't nearly as clear. Just because someone is a friend or a family member doesn't mean he or she isn't a business associate. Don't pay for your business out of your own pocket, you could be missing out on a lot of tax deduction savings.
Let's suppose that your mother watched the kids because the babysitter didn't show, and you had to do an interview. You thank her by sending flowers. You can then write off that expense. The limit for gift deductions is $25 per gift. You should make a note on the receipt that it was a gift for mom because she watched the kids while you did an interview.
Or say an information-technology consultant is going out on her own, and her husband is in the ad business. She wants him to look at her brochure and help lay out a business plan, so they go out to dinner. She can write it off even though it's with her husband. She couldn't have had that dinner at home with the kids running around. You can't just write off every dinner, but if there's a business motive, you can.
Another example where you don't want to discount an expense because there's a personal connection would be if you make something like gift baskets at home and deliver them while dropping the kids off at school. Driving around delivering those gift baskets counts as business miles. If you go from your home office to the school, and from the school to the client, then just the miles from the school to the office count as business miles. But if the client is on the way to the school, and you drop the baskets off, the whole trip counts.
Try to look at everything that you do as a possible business connection and define your business as broadly as you can. From that standpoint, ou might define what you do as tech consulting rather than just computer repair. If you're a writer who's a generalist, you can write off a lot more business expenses than if you wrote only about sports.
The IRS says that an expense must be ordinary and necessary to qualify as a business expense and be tax write off. The IRS defines necessary as "appropriate and helpful." What counts as ordinary? If a computer-game developer buys other people's games, that's an ordinary expense to him. The computer game in itself is not an ordinary expense for me unless I'm writing and have the potential to write about computers or what effect computer games have on the brain.
I tell people to get a written backup for every dollar they spend, whether it's a canceled check, credit-card slip, or a receipt for cash. Just buy something, keep the slips in an allotted space, and then you can go over it later. I don't want people to be thinking about whether their spending is personal or for business all the time.
Using one credit card can make your record-keeping easier. The more papers and more statements that come in, the less organized someone is going to be. I always say if a piece of paper comes in, and your name isn't on it, throw it out.
My belief is this: Don't worry about them. The IRS puts up red flags to scare you. If you're a legitimate self-employed person, take every deduction you can, and don't let the big boys push you around.
If you make a profit in three consecutive years out of five, the IRS will tend not to look at you. If you write a book, and it takes 10 years, you're going to have a loss for 10 years, and that's fine as long as you can prove that you're in it to make money -- that your goal is a profit.
The first thing the IRS says is that you should have a business card. Someone like an info-tech consultant who isn't getting jobs should save the proposals that show that he or she is out there looking for work.
Provided you actually do work from a home office and have the records to back it up, there is nothing to worry about taking the home office deduction. It's a scare tactic. And so what if they audit you? If you have good record-keeping, an audit is nothing. Also, office-in-the-home regulations have been liberalized.
Say an info-tech consultant shares an office in town with another consultant and has computers there because she lives in a small apartment. Of course, she can deduct rent for the office. But as long as she has a place at home used exclusively for work -- suppose she bills from there -- she can write off that area, though it will be a small write-off.
More significant is the deduction she'll be allowed to take for travel between the two offices. If she didn't have the home office, she couldn't take that deduction either.
One of the biggest mistakes many people make is that they don't keep track of their income. They may not realize if the client makes a mistake in reporting to them and, more important, to the IRS. You need to keep your own records, too. Another mistake is not taking enough write offs, and paying for business expenses with personal funds. It is a good idea to consult with a tax professional to maximize the amount of tax deductions you can take. Sign up below for a free strategy session to go over the tax deductions that apply to your unique situation.
To learn more tax saving strategies, please see our Tax Write Offs page.