There are a lot of moving parts to keep track of during a tax year, especially when it comes to seeing where you can get a tax credit. Since taxes are unavoidable, it’s important to understand how your local business can use allowable deductions to minimize the amount you owe when it’s time to file.
This guide will go over what qualifies as an allowable deduction, as well as how you can ensure you’re getting the most out of this potentially money-saving part of the tax code. It’ll also cover tips on how to file self-employment taxes so you’ll feel more confident every tax season.
What is an Allowable Deduction?
To get started, let’s address an important question—what are allowable deductions?
Simply put, allowable deductions are business costs that aren’t taxed. You can subtract them from your adjusted gross income at the end of the year to get a tax break.
These costs are an itemized deduction, and have to be tracked and reported, usually using the Schedule A Form 1040. It’s incredibly important to be thorough if you decide to file with allowable deductions since there’s always a chance you could be audited.
Claiming allowable deductions on your federal tax return can lower the amount of taxes you owe since it reduces the gross amount you’re responsible for paying taxes on overall. To make it easy, let’s take a look at an overly-simplified hypothetical example:
- Your business made $100,000 last year. You claim $20,000 in allowable deductions. Now, you’re only responsible for paying taxes on $80,000 of your income.
However, not just any expense qualifies, and there are specific guidelines and rules you need to follow to meet IRS stipulations. It’s also important to note that most taxpayers (90% according to Investopedia), don’t itemize their deductions. Instead, they claim the standard deduction, which requires less paperwork and record keeping on taxable income.
So, how do you know if you should take the standard deduction or if you should record your deductions individually? If you have a substantial amount of business-related costs (over $12,550 worth for those filing individually in 2021), which many small businesses do, itemizing your allowable deductions may serve you better.
Examples of Allowable Deductions
More than likely, there are things you didn’t even realize you could count as a deduction on your federal tax return. This could mean you’ve been handing over more than needed to the IRS over the years. Let’s take a look at this list of allowable deductions, as well as a few helpful pointers on what doesn’t qualify as an allowable deduction:
Fully Allowable Expenses - The IRS defines these types of expenses, which you can deduct at 100% of their value, as expenses that are, “ordinary and necessary.” They’re things that are directly tied to your business and that you couldn't conduct business without. Examples include:- Office supplies
- Office space
- Utilities
- Work-related travel expenses
- Work-related automobile expenses
- Insurance
- Employee salaries and benefits
- Advertising and marketing
- Licenses, permits, and subscriptions
- Charitable donations
- Meals
Partially Allowable Expenses - These expenses are related to your business, but only a specified percentage can be deducted. The primary example of this is gifts. If you want to express your appreciation to a client or an employee with a gift, keep in mind you can only deduct up to $25 of its value.
It’s also important to remember that tax laws change frequently. Just because something qualified as an allowable deduction in the past, doesn’t mean you’re automatically in the clear to write it off. The standard itemized deduction amount also changes. Stay on top of the current tax code to ensure you’re making the best decisions for your business.
An example of tax laws changing can be seen in the rules for counting meals as a tax deduction. In the past, only 50% of a business-related meal could be deducted. However, as a result of the pandemic and in an effort to bolster spending, the government now allows you to deduct 100% of meal costs until 2022. This is welcome news for both people in the restaurant industry and for business owners who often take clients out to eat.
As a taxpayer, if you’re not sure what qualifies as an allowable deduction, be sure to consult the IRS website, or enlist the services of a professional accountant.
Tracking Your Deductions
Organization is your best friend during tax season, especially when it comes to staying on top of each tax deduction. To make sure you have all your ducks in a row before tax season, be sure to take the following steps throughout the year:
- Record and track all of your business-related purchases and expenses
- Maintain an ongoing spreadsheet with dates, amounts, and descriptions
- Ensure all your employees are up to date on expense-tracking protocols
- Don’t throw away your records—you may need records from past years if you’re audited
Filing Self-Employment Taxes
Now that you understand what qualifies as an allowable deduction, let’s take a closer look at how to file self-employment taxes. Whether you’re new to handling your own taxes, or you’ve been self-employed for years, brushing up on your financial literacy never hurts.
Who Should File Self-Employment Taxes?
According to the IRS, if you fall into one of the following categories, and you’ve made over $400 in the last year, you’re considered self-employed:
- You carry on a trade or business as a sole proprietor or an independent contractor.
- You are a member of a partnership that carries on a trade or business.
- You are otherwise in business for yourself (including a part-time business)
If you fall in either of these categories, that means the government doesn’t automatically withhold money to pay your taxes. You are responsible for not only paying annual taxes, but you also need to file quarterly with the IRS.
Federal, state, and local taxes aren’t the only things you have to pay. You’ll also have to pay the self-employment tax, which goes toward Medicare and Social Security (if this is new to you, it’s because employers are usually responsible for withholding these). The current combined rate is 15.3%. One piece of good news is, if your business makes over $137,770, you’ll only have to pay Social Security taxes up to that amount.
Tips for Filing Self-Employment Taxes
While handling taxes as a small business owner isn't easy, there are ways you can make it less stressful. By keeping the following tips in mind, your taxes won’t seem as taxing:
- Stay on top of your quarterly payments
- Consider incorporating as your business grows—it may save you money
- Set money aside for tax payments so you don’t come up short when they’re due
- Be thorough when reporting your allowable deductions
- Stay vigilant and meticulous when it comes to tracking your finances
As counter-intuitive as it may seem, one of the keys to keeping your tax burden low is actually keeping your business profits low. This is because taxes are calculated based on net profits, rather than the net revenue of a business. It’s also why it’s so important to know how to use deductions to your advantage.
Don’t let tax day slip up on you! Filing late can result in hefty fees—typically 5% of what you owe for every month your payment is late.
You’re Not Alone—Find an Accountant on Nextdoor
If you’re feeling overwhelmed, don’t worry. There’s an entire industry of people who go through extensive education and training to help business owners like you handle their taxes. Certified public accountants know how to keep the most money in your pocket, and they’ll also help you avoid any costly mistakes.
If you’re looking for tax help in your neighborhood, turn to Nextdoor. Connect with neighbors and get recommendations for nearby accountants. Since Nextdoor is hyper-local and 100% verified, you can feel confident you’re choosing an accountant your neighbors have had success with.
Sources:
Debitoor. Allowable expenses – What are allowable expenses?. https://debitoor.com/dictionary/allowable-expenses
Investopedia. Deductions. https://www.investopedia.com/terms/d/deduction.asp
IRS. Deducting Business Expenses. https://www.irs.gov/businesses/small-businesses-self-employed/deducting-business-expenses
IRS. Self-Employed Individuals Tax Center. https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center
SmartAsset. All About Self-Employment Taxes. https://smartasset.com/taxes/self-employment-tax
IRS. Eight Facts on Late Filing and Late Payment Penalties. https://www.irs.gov/newsroom/eight-facts-on-late-filing-and-late-payment-penalties
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