Tax Planning for Self-Employed Business Owners

Guidebook 01
Tax Planning for
Self-Employed
Business Owners
& Independent
Contractors

01.
02.
03.
04.
05.
06.
07.
08.
What It Means to Be
Self-Employed
Are You Really an
Independent Contractor?
What If Your Business Loses
Money?
Choosing How to Legally
Organize Your Business
Why Tax Deductions Are So
Important
Deducting Your Business
Operating Expenses
Deductions When You Drive
for Business
Deductions When You Travel
Out of Town for Business
Table of Contents
09.
10.
11.
12.
13.
14.
15.
16.
Deducting Business Meals
and Entertainment Expenses
Deducting Equipment and
Other Business Assets
Deducting Your Home Office
Inventory Deductions When
You Make or Sell Items
Affordable Care Act,
Health Expenses, and the
Self-Employed
Paying Estimated Taxes
Filing Your Tax Return
Recordkeeping and
Accounting

Chapter 1:
What It Means to
Be Self–Employed
“It seems the harder I work,
the more luck I have.”
— Thomas Jefferson

Being self-employed means running a one-owner business.
Most self-employed individuals work by themselves, although
they can have employees or other self-employed people work
for them as well.
The topic of self-employment can get confusing because
self-employed people use a variety of labels to describe them-
selves other than “self-employed,” including:
Contract Worker
Contingent Worker
Creative Professional
Business Owner
One-Person Business Owner
Freelancer
Consultant
Entrepreneur
Soloprenuer
Micropreneur
Microbusiness Owner
Home Business Owner
Independent Worker
Independent Contractor
36%
Prefer the Term
“Self-Employed.”
Chapter One:
What It Means to Be Self–Employed

These labels are often used interchangeably. Some mean dif-
ferent things in different businesses or professions. None has
any legal significance except for the last: An “independent con-
tractor” is a worker who is not classified as an employee for tax
and other legal purposes (see Chapter 2). Thus, self-employed
people are independent contractors.
You are free to call yourself anything you want. One recent
survey found that a plurality of people who work for themselves
prefer the following labels:
Whatever you call yourself, you have plenty of company.
According to the Bureau of Labor Statistics, one in nine
American workers is self-employed; other estimates place
the number as high as one in six. In fact, four out of ten adult
Americans are either currently working or have worked as
independent contractors at some point during their careers.
1 in 9
American
workers
is self-
employed.
15%
Independent
Contractor
36%
Self-Employed
13%
Business Owner

Self-employed people do all types of work, including high-skill
knowledge and creative occupations and lower-skill service
work. This can include everything from app and website develop-
ment to driving a car for Uber or Lyft.
Self-employment can be both financially and spiritually reward-
ing. Most self-employed people say they are very satisfied with
their work situation. Moreover, the self-employed account for
two-thirds of all American millionaires.
Self-
employed
account
for 2/3 of
all American
millionaires.
26.7%
Workers in the
arts, entertain-
ment, and
media
22.8%
Personal care
22.6%
Construction
and extraction
17.6%
Building
and grounds
cleaning
17.2%
Legal
16.2%
Management
8.1%
Sales
According to the Bureau of
Labor Statistics, self-employment
rates are highest for:

However, being self-employed is not always easy. Many
self-employed people (including those with plenty of business)
get into trouble because they don’t run their operations in a busi-
nesslike manner. You don’t have to start wearing a green visor
and bow tie, but you do need to learn a few rudiments of busi-
ness and tax law.
The vast majority of the self-employed—about 80%—are sole
proprietors who have no taxes withheld from their earnings and
can take advantage of a huge array of tax deductions available
only to business owners. Because of these and other tax benefits,
the self-employed often ultimately pay less in taxes than employ-
ees who earn similar incomes.
Self-
employed
often
ultimately
pay less in
taxes.
It’s important to understand
that when you’re self-em-
ployed, you live in a differ-
ent tax universe from wage
earners—those who work in
other people’s businesses
or for the government. Wage
earners have their income
taxes withheld from their
paychecks and can take rela-
tively few deductions.

However, with tax benefits come drawbacks as well.
For example, self-employed people must pay all of their Social
Security and Medicare taxes themselves. In contrast, employees
only pay half of these taxes. The self-employed also have to pay
estimated taxes to the IRS four times per year and have to file a
more complex tax return than most employees.
To take advantage of the many tax deductions available to busi-
ness owners, you’ll have to figure out which deductions you are
entitled to take and keep proper records of your expenses. The
IRS will never complain if you don’t take all of the deductions
to which you are entitled. In fact, the majority of self-employed
people miss out on many deductions every year simply because
they aren’t aware of them—or because they neglect to keep the
records necessary to support them.
This book serves as a guide to tax basics when
you’re self-employed, including choosing how
to legally organize your business, claim tax
deductions, pay estimated taxes, comply with
the requirements of the ACA, meet tax filing
requirements, and preserve your status as a
self-employed independent contractor for tax
and other legal purposes.

Chapter 2:
Are You Really an
Independent Contractor?
“Make the most of
yourself, for that is
all there is of you.”
— Ralph Waldo Emerson

Chapter Two:
Are You Really an Independent Contractor?
The world of work is rapidly changing. However, the law hasn’t
kept up. For tax and other legal purposes, there are only two
things an individual worker can be: an employee or an
independent contractor.
If you’re self-employed—that is, you run a one-owner business—
you should be classified as an independent contractor by the
clients that hire and pay you, and by the government, not as an
employee. This chapter shows you how to safeguard your legal
status as an independent contractor.
Who Determines Whether You’re an Independent Contractor?
Initially, it’s up to you and each hiring firm you deal with to decide
whether you should be classified as an independent contractor or
employee. But the decision about how you should be classified is
subject to review by various government agencies, including:
• the IRS
• your state’s tax department
• your state’s unemployment
compensation insurance agency
• your state’s workers’ compensa-
tion insurance agency
• the U.S. Department of Labor
and the National Labor
Relations Board

Because independent contractors often cost less than employ-
ees, some employers classify their workers as contractors even
though they are really employees.
The IRS considers worker misclassification to be a serious prob-
lem that costs the U.S. government billions of dollars in taxes
that would otherwise be paid if the workers were classified as
employees and taxes were automatically withheld from their pay-
checks. Most state agencies live by the same theory.
With the advent of the “sharing
economy,” and the rise of compa-
nies like Uber and Lyft that employ
thousands of drivers who are clas-
sified as independent contractors,
the worker classification issue has
become hotter than ever.
Tests for Determining Worker Status
Most, but not all, government agencies use the “right of control”
test to determine whether you’re an employee or independent
contractor. You’re an employee under this test if a hiring firm has
the right to direct and control how you work, both as to the final
results and as to the details of when, where, and how you per-
form the work.
One federal study found that employers misclassified
3.4 million workers as independent contractors, while
the Labor Department estimates that up to 30% of
companies misclassify employees.
30%
of companies
misclassify
employees

The employer may not always exercise this right. For example, if
you’re experienced and well trained, your employer may not feel
the need to closely supervise you. But if the employer has the
right to do so, you’re still considered an employee.
In contrast, you’re an independent contractor if the hiring firm
does not have the right to control how you do the job. Because
you’re an independent businessperson not solely dependent
on the firm for your livelihood, the firm’s control is limited to
accepting or rejecting the final results you achieve. Or, if a proj-
ect is broken down into stages or phases, the firm’s input is lim-
ited to approving the work you perform at each stage. Unlike an
employee, you are not supervised daily.
It can be difficult to figure out whether a hiring firm has the right
to control you. Government auditors can’t read your mind to see
if you are controlled by a hiring firm. They have to rely instead
on indirect or circumstantial evidence indicating control or lack
thereof, such as whether a hiring firm provides you with tools and
equipment, where you do the work, how you’re paid, and whether
you can be fired.
The factors each government agency relies upon to measure
control vary. The IRS looks at three broad areas to determine
whether a hiring firm has the right to control a worker. These are:
• your behavior on the job
• your finances, and
• your relationship with the hiring firm.
Some agencies look at 14 factors to see if you’re an employee or inde-
pendent contractor; some look at 11; some consider only three. The
IRS test is the most important and influential. 3
1114

The following chart shows the primary factors the IRS looks at in
each area.
IRS Test for Worker Status
Factors
You will more likely
be considered self-
employed if you:
be considered an
employee if you:
Behavioral Control
Factors showing whether
a hiring firm has the right
to control how you per-
form the specific tasks
you’ve been hired to do
• are not given instruc-
tions by the hiring
firm
• provide your own
training
• receive instructions
you must follow about
how to do your work
• receive training from
the hiring firm
Financial Control
Factors showing
whether a firm has a
right to control your
financial life
• have a significant
investment in equip-
ment and facilities
• pay business or travel
expenses yourself
• make your services
available to the public
• are paid by the job
• have opportunity for
profit or loss
• use equipment and
facilities provided by
the hiring firm free of
charge
• are reimbursed for
your business or trav-
eling expenses
• make no effort to mar-
ket your services to the
public
• are paid by the hour or
other unit of time
• have no opportunity
for profit or loss (for
example, because
you’re paid by the hour
and have all expenses
reimbursed)

IRS Test for Worker Status
Factors
be considered self-
employed if you:
be considered an
employee if you:
Relationship
Between Worker
and Hiring Firm
Factors showing whether
you and the hiring firm
believe that you are self-em-
ployed or an employee
• don’t receive employee
• benefits such as health
insurance
• sign a client agreement
with the hiring firm
• can’t quit or be fired
at will
• are performing services
that are not a part of
the hiring firm’s regular
business activities
• receive employee
benefits
• have no written client
agreement
• can quit at any time
without incurring any
liability to the hiring
firm
• can be fired at any time
• are performing services
that are part of the hir-
ing firm’s core business
The IRS test is not a model of clarity. There is no guidance on
how important each factor is and how many factors must weigh
in favor of independent contractor status for you to be classified
as an independent contractor. The IRS says there is no magic
number of factors. Rather, the factors that show lack of control
must outweigh those that indicate control. No one factor alone is
enough to make you an employee or an independent contractor.
Sometimes, it’s easy to tell if a worker is an independent contrac-
tor or employee using the IRS test. For example, a person who
works as a barista at your local café is obviously an employee.
Likewise, a plumber who such a café hires to fix a plumbing prob-
lem is clearly an independent contractor, not the café’s employee.

Eight Things You Should Do to Avoid Being Classified as an Employee
If the IRS or another government agency audits you or a hiring
firm you’ve worked for and determines that you should have
been classified as an employee instead of an independent con-
tractor, it can and probably will impose assessments and penal-
ties on the firm. Some companies have gone bankrupt because
of such assessments.
Rest assured, however, that the government will not penalize
or fine you if you’ve been misclassified as an independent con-
tractor. However, you can be affected adversely in other ways.
For example, the hiring firm may end the working relationship
because it doesn’t want to pay the additional expenses involved
in treating you as an employee. It is not unusual for IRS set-
tlement agreements with hiring firms to require that the firms
terminate contracts with independent contractors even if the
independent contractors would prefer that those agreements
continue. Or, the hiring firm may insist on reducing your compen-
sation to make up for the extra employee expenses. And even if
none of these things happen, you’ll likely be treated differently
on the job. For example, the hiring firm—now your employer—will
probably expect you to follow its orders and may attempt to
restrict you from working for other companies.
Joe works part-time as a driver for Lyft and Uber. Joe pro-
vides his own vehicle and works only when he wants to. He
has also signed agreements with Uber and Lyft stating that
he is an independent contractor. However, Uber and Lyft
set the rates Joe can charge, collect the money, make drivers
undergo a lengthy application process, and terminate driv-
ers who don’t conform to their detailed standards.
So, is Joe an
independent
contractor or
an employee?
Unfortunately, the answer
is far from clear (and is
currently undergoing liti-
gation in several states).
Consider this example:

An IRS determination that you should be classified as an
employee can also have adverse tax consequences for you. You
may not be able to deduct unreimbursed expenses incurred
while you were an employee, or the deductions may be limited.
The change to employee status may also increase your tax bill
because you must now compute FICA tax on your gross wages
instead of computing self-employment tax on your net income.
Your employer will also have to start withholding your income
tax and FICA tax from your pay. (On the plus side, however, your
employer will have to pay half of your Social Security and Medicare
tax and you’ll be entitled to a refund of half the taxes you paid your-
self while you were misclassified as an independent contractor.)
If you want to be an independent contractor, not an employee,
it’s wise to take some simple steps that will convince the
IRS and other government agencies that you really are an
independent contractor.

1. Retain control of your work
The most fundamental difference between employees and inde-
pendent contractors is that employers have the right to tell their
employees what to do. Never permit a hiring firm to supervise or
control you as it does its employees. It’s perfectly all right for the
hiring firm to give you detailed guidelines or specifications for the
results you’re to achieve. But how you go about achieving those
results should be entirely up to you.
A few guidelines will help emphasize that you are the one who
is responsible:
• Do not ask for or accept instructions or orders from the hiring
firm about how to do your job.
• Do not ask for or receive training on how to do your work from a
hiring firm. If you need additional training, seek it elsewhere.
• A hiring firm may give you a deadline for when your work
should be completed, but you should generally establish your
own working hours.
• Decide on your own the location from which to perform the work.
A client should not require you to work at a particular location.

• Decide whether to hire assistants to help you, and, if you do,
pay and supervise them yourself.
• Do not attend regular employee meetings or functions such as
employee picnics.
• Avoid providing frequent formal reports about the progress of your
work, such as daily phone calls to the client. It is permissible, how-
ever, to give reports when you complete various stages of a project.
• Do not obtain, read, or pay any attention to a hiring firm’s
employee manuals or other rules for employees.
2. Show opportunities for profit or loss
Because they are in business for themselves, independent con-
tractors have the opportunity to earn profits or suffer losses. If
you have absolutely no risk of loss, you’re probably not an inde-
pendent contractor. The best way to show an opportunity to
realize profit or loss is to have recurring business expenses. If
receipts do not match expenses, you lose money and may go
into debt. If receipts exceed expenses, you earn a profit. Such
expenses may include such items as office rent, salaries for
assistants, travel expenses, equipment and materials, insurance,
advertising, and many others.
Another excellent way to show opportunity for profit or loss is
to be paid an agreed upon price for a specific project, rather
than to bill by unit of time, such as by the hour. If the project
price is higher than the expenses, you’ll make money; if not,
you’ll lose money.

3. Look like an independent business
Take steps to make yourself look like an independent businessper-
son. There are several things you can do to cultivate this image:
• Don’t obtain employee-type benefits from your clients, such
as health insurance, paid vacation, sick days, pension ben-
efits, or life or disability insurance; instead, charge your cli-
ents enough to purchase these items yourself.
• Obtain a fictitious business name instead of using your own
name for your business.
• Obtain all necessary business licenses and permits.
• Obtain business insurance.
4. Work outside hiring firms’ premises
Unless the nature of the services you’re performing requires it,
don’t work at the hiring firm’s office or other business premises.
Working at a location specified by a hiring firm implies that the
firm has control, especially if the work could be done elsewhere.
5. Make your services widely available
Independent contractors normally offer their services to the gen-
eral public, not just to one person or entity. Thus, you should make
efforts to market your services, such as establishing a website.
6. Have multiple clients
IRS guidelines provide that you can work full time for a single cli-
ent on a long-term basis and still be an independent contractor.
Nevertheless, having multiple clients shows that you’re running
an independent business because you are not dependent on any

one firm for your livelihood. Government auditors will rarely ques-
tion the status of an independent contractor who works for three
or four clients simultaneously.
7. Use written agreements
Use written independent contractor agreements for all but the
briefest, smallest projects. Among other things, the agreement
should make clear that you are an independent contractor and
the hiring firm does not have the right to control the way you
work. A written agreement by itself won’t make you an indepen-
dent contractor, but it is helpful, particularly if you draft it rather
than the hiring firm.
8. Avoid accepting employee status
It’s best to avoid performing the exact same services while clas-
sified as both an independent contractor and employee. Being
classified as both on your tax return may make an IRS audit more
likely and lead government auditors to conclude that you’re an
employee for all purposes.

Chapter 3:
What If Your Business
Loses Money?
“Wealth is the ability to
fully experience life.”
— Henry David Thoreau

Chapter Three:
What If Your Business Loses Money?
If the money you spend on your business exceeds your business
income for the year, your business incurs a loss. Unfortunately,
such losses are very common, especially when small businesses
are starting out. Indeed, in 2013 alone, over 1.2 million taxpayers
reported losses from business activities on their tax returns.
However, there is a bright side: You can use a business loss to off-
set other income you may have, such as interest income or your
spouse’s income if you file jointly. You can even accumulate your
losses and apply them to reduce your income taxes in future or
past years.
The Danger of Recurring Losses
There is no shame in having a business loss, and it can have tax
advantages as described below. However, if you keep incurring
losses year after year, your chances of getting audited by the IRS
significantly increase. If you are audited, you could easily run afoul
of the “hobby loss rule.” This rule could cost you a fortune in addi-
tional income taxes.
Ventures that don’t qualify as businesses are called hobbies.
Unlike business expenses, expenses for a hobby are personal
The IRS created the hobby loss rule to prevent taxpayers from enter-
ing into money-losing ventures primarily to incur expenses they could
deduct from their other incomes. In the IRS’ view, such ventures are
not real businesses—they are justa means to dodge taxes.

expenses that you can deduct only from income you earn from
the hobby. They can’t be applied to your other income, such as
you or your spouse’s salary or interest income. You want to do
everything possible to avoid having your venture classified as a
hobby by an IRS auditor.
When Is an Activity a Business?
An activity is a business if you engage in it primarily to make a
profit. It’s not necessary that you earn a profit every year. All that
is required is that your main reason for doing what you do is to
make a profit. A hobby is any activity you engage in mainly for a
reason other than making a profit—for example, to incur deduct-
ible expenses or just to have fun.
The IRS can’t read your mind to determine whether you want to
earn a profit. And it certainly isn’t going to take your word for it.
Instead, it looks to see whether you do actually earn a profit or
behave as if you want to earn a profit. It uses two tests to make
this determination: the profit test and the behavior test.
Profit Test
If your venture earns a profit in three out
of five consecutive years, the IRS pre-
sumes that you have a profit motive. The
IRS and courts look at your tax returns
for each year you claim to be in business
to see whether you turned a profit. Any
legitimate profit—no matter how small—
qualifies; you don’t have to earn a particular amount or percent-
age. Careful year-end planning can help your business show a
profit for the year. If clients owe you money, for example, you can

press for payment before the end of the year. You can also put off
paying expenses or buying new equipment until the next tax year.
The presumption that you are in business applies to your third
profitable year and extends to all later years within the five-year
period beginning with your first profitable year.
Behavior Test
If you keep incurring losses and can’t satisfy the profit test, you
by no means have to throw in the towel and treat your venture
as a hobby. You can continue to treat it as a business and fully
deduct your losses. However, you should take steps to convince
the IRS that your business is not a hobby in case you’re audited.
You must be able to convince the IRS that earning a profit—not hav-
ing fun or accumulating tax deductions—is the primary motive for
what you do. This can be particularly difficult if you’re engaged in an
activity that could objectively be considered fun—for example, creat-
ing artwork, photography, or writing—but it can still be done.
You must convince
the IRS that earn-
ing a profit is the
primary motive for
what you do.

You must show the IRS that your behavior is consistent with that
of a person who really wants to make money. There are many
ways to accomplish this.
First and foremost, you must show that you carry on your enter-
prise in a businesslike manner. For example, you:
• maintain a separate checking account for your business
• keep good business records
• make some effort to market your services (for example, have
a business website, business cards, and, if appropriate, a
yellow pages or similar advertisement)
• have business stationery and cards printed
• obtain all necessary business licenses and permits
• have a separate phone line for your business if you work at
home (this can be a cell phone)
• join professional organizations and associations, and
• develop expertise in your field by attending educational
seminars and similar activities.
You should also draw up a business plan with forecasts of reve-
nue and expenses. This will be helpful if you try to borrow money
for your business.
Deducting Business Losses From Your Taxes
If, like most self-employed people, you’re a sole proprietor
or owner of a single member limited liability company (LLC),
you may deduct any loss your business incurs from your other
income for the year (including income from a job, investment
income, or your spouse’s income if you file a joint return). If your
losses exceed your income from all sources for the year, you

have a “net operating loss” (NOL). While it’s not pleasant to lose
money, an NOL can provide important tax benefits: You can use it
to reduce your tax liability for both past and future years.
Carrying a loss back
You may apply an NOL to past tax years by filing an application for
a refund or amended return for those years. This is called carrying
a loss back. (IRC § 172.) As a general rule, it’s advisable to carry a
loss back so that you can get a quick refund from the IRS on your
prior years’ taxes. However, this may not be a good idea if you paid
no income tax in prior years, or if you expect your income to rise
substantially and you want to use your NOL when you’re subject to
a higher tax rate.
Ordinarily, you may carry back an NOL for the two years before the
year you incurred the loss. The NOL is used to offset the taxable
income for the earliest year first, and it is then applied to the next
year(s). This will reduce the tax you had to pay for those years and
result in a tax refund. Any part of your NOL left after using it for the
carryback years is carried forward for use for future years.
Carrying a Loss Forward
You also have the option of applying your NOL only to future tax
years. This is called carrying a loss forward. You may carry the NOL
forward for up to 20 years and use it to reduce your taxable income
in the future. You elect to carry a loss forward by attaching a written
statement to your tax return for the year you incur the loss.
To learn more about NOLs, refer to IRS Publication 536,
Net Operating Losses.

Chapter 4:
Choosing How to
Legally Organize
Your Business
“If you don’t know where
you are going, you might
wind up somewhere else.”
— Yogi Berra

One of the first things you need to do when you become self-em-
ployed is decide whether you should be a sole proprietor or
form a separate legal entity to operate your business. Many
self-employed people don’t give this issue much thought, but
it is important. How you legally organize your business affects
the taxes you pay, your personal liability for business debts, and
whether it will be easy or hard to attract investors.
However, don’t worry about making the “wrong” choice. Quite
simply, there is no wrong choice. There is no one legal form that
is best for everybody. It all depends on your goals and unique
circumstances. Moreover, your initial choice about how to orga-
nize your business is not set in stone. You can always switch to
another legal form later. It’s common, for example, for self-em-
ployed people to start out as sole proprietors, then incorporate
or form LLCs later when they become better established and
make substantial income.
What Are Your Choices?
There are four main business forms that we’ll discuss:
• sole proprietorship
• corporation
• partnership, and
• limited liability company (LLC).
Chapter Four:
Choosing How to Legally Organize
Your Business

If you own your business alone, you need not be concerned
about partnerships; this business form requires two or more
owners. If, like most self-employed workers, you’re running a
one-person business, your choice is between a sole proprietor-
ship, corporation, or LLC.
What Are Your Goals?
Each of these legal forms has its pros and cons. Which is best for
you depends on what you want your legal form to do for you.
1. You Want to Keep Life Simple, Easy, and Cheap
If you want to keep things simple, easy, and cheap, you should
go with the sole proprietorship. This is what most self-employed
people do. The great majority of all businesses are organized as
sole proprietorships. In 2012, there were more than 23.5 million
sole proprietorships out of 34.6 million total businesses that filed
tax returns.
What is a sole proprietorship? It is a
one-owner business. It is simply you
doing business. You personally own
all of your business assets. This is by
far the cheapest and easiest way to
do business.
You don’t have to form a separate legal entity like a corporation or
LLC. You just start doing business; if you don’t incorporate or have
a partner, you are automatically a sole proprietor. If you’re already
running a one-person business and haven’t incorporated or formed
an LLC, you’re a sole proprietor now.

The cost of forming a sole proprietorship is often zero. However,
you may need to file a fictitious business statement and pay a
small fee if you use a name other than your personal name for
your business. You generally do this in the county where your
office is located; check your county government website for
details. You may also need to obtain a local business license and
pay a licensing fee. (In a few states, like Nevada and Washington,
you need a state business license.) You don’t need to obtain
a federal employer ID number from the IRS unless you have
employees. In fact, you don’t even need a separate business
bank account, although one is often desirable.
When you’re a sole proprietor, you and your business are one and
the same for tax purposes. You don’t pay taxes or file tax returns
separately for your sole proprietorship. Instead, you report the
income you earn or losses you incur on your own personal tax
return on IRS Form 1040. If you earn a profit, you add the money
to any other income you have, such as interest income or your
spouse’s income if you’re married and file a joint tax return. That
becomes the total that is taxed. If you incur a loss, you may use
it to offset income from other sources. This type of tax treatment

is ideal for most small business owners, particularly if they incur
losses within the first few years they are in business.
To show whether you have a profit or loss from your sole pro-
prietorship, you must file IRS Schedule C, Profit or Loss From
Business, with your tax return. On this form, you will list all of
your business income and deductible expenses. This is the sim-
plest way to handle your taxes when you’re in business.
Sole proprietors are not employ-
ees of their proprietorships; they
are business owners. Their busi-
nesses don’t pay payroll taxes
on a sole proprietor’s income or
withhold income tax. However,
sole proprietors do have to pay
self-employment taxes—that is,
Social Security and Medicare
taxes—on their net self-employment income. These taxes must be
paid four times a year (along with income taxes) in the form of esti-
mated taxes (see Chapter 15). Thus, you won’t save any money on
Social Security and Medicare taxes by being a sole proprietor.
Another advantage of being a sole proprietor is that it’s easy to
close your business: You simply stop working in the business
Hiring firms don’t withhold any taxes from a sole proprietor’s com-
pensation, but any firm that pays a sole proprietor $600 or more in
a year must file Form 1099-MISC to report the payment to the IRS.

and don’t include Schedule C on your tax return (you might also
have to cancel your business license and/or fictitious business
name statement).
2. You Want to Limit Your Liability
So, if the sole proprietorship form is so great, why do millions
of small business owners go to the time and trouble of forming
business entities like corporations and limited liability compa-
nies? It’s because sole proprietorships have one big drawback:
They provide no limited liability for their owners.
When you’re a sole proprietor,
you are personally liable for all
the debts of your business. This
means that a business creditor
can go after all of your assets,
both business and personal.
This may include, for example,
your personal bank accounts,
your car, and even your house.
Similarly, a personal creditor—a
SOLE PROPRIETORSHIP
Just you doing
business
No expense to
maintain
Liability
File IRS
Schedule C
Pay Social Security
and Medicare Tax

person or company to whom you owe money for personal items—
can go after your business assets, such as business bank accounts.
If you’re a sole proprietor, you’ll also be personally liable for busi-
ness-related lawsuits.
By far the main reason small business owners choose to form
legal entities instead of being sole proprietors is to obtain limited
liability. “Limited liability” means your personal assets are not
subject to business debts or lawsuits.
For a one-person business, the limited liability entity of choice is
the limited liability company (LLC for short). LLCs are extremely
popular because they give you the same limited liability as
a corporation, but are easier to form and operate. To estab-
lish an LLC, you file articles of organization with your state’s
business filing office (usually, the Secretary of State). You can
do this yourself. There are many online resources to help you
(see, for example, http://www.nolo.com/legal-encyclopedia/
limited-liability-company).
When you establish a single-member LLC (SMLLC), you will con-
tinue to be taxed like a sole proprietor—filing Schedule C to
report your income and expense. At the same time, you are the
owner of a separate legal entity that holds title to your business
assets, like your business bank account, equipment, and even
business real estate. Your LLC can also sue and be sued. For
many one-person business owners, this is ideal.
Moreover, while forming an LLC may insulate you from
some types of lawsuits, it won’t protect you from personal
liability for your own negligence or other wrongdoing.
That’s why
you need
insurance.

However, before you jump on the LLC bandwagon, you should be
aware that there are limits on limited liability provided by an LLC.
In theory, when you do business through an LLC, only the assets
of the LLC can be reached by creditors. However, in reality, it usu-
ally doesn’t work out this way for small business owners. Major
creditors (like banks and business credit card issuers) are proba-
bly not going to let you shield your personal assets by forming an
LLC. Instead, they will likely demand that you personally guaran-
tee business loans or extensions of credit. This is especially likely
when you are first starting out and don’t have an established busi-
ness credit record. This means that you will be personally liable for
the debt, just as if you were a sole proprietor. Not only banks and
lenders require personal guarantees; other creditors may as well.
For example, you may be required to personally guarantee payment
of your office lease or leases for expensive equipment.
Finally, an LLC can be expensive to maintain. Most states charge
annual fees and/or minimum taxes that LLC owners must pay
each year. These vary from state-to-state. In California, for exam-
ple, you must pay a minimum annual franchise tax of $800 to
have an LLC. California also imposes a 1.5% additional tax on LLC
profits over $250,000. Many self-employed people would be bet-
ter off remaining sole proprietors and using the money they save
to purchase liability insurance.
LIMITED LIABILITY CO.
Personal assets
protected
Some expense to
maintain
File IRS
Schedule C
Pay Social Security
and Medicare Tax

Despite these drawbacks, if your main goal is to limit your per-
sonal liability as much as possible, you should form a limited
liability company.
3. You Want to Save On Social Security and Medicare taxes
When you’re self-employed, you have to pay all of your Social
Security and Medicare taxes out of your own pocket. You don’t
have an employer to pay half of them for you. These taxes are
substantial: a flat 15.3% tax on your first $118,500 in net self-em-
ployment income (in 2015). If you earn more than that amount,
you must pay additional Medicare taxes (a 2.9% tax on your
income up to $200,000 if you’re single or $250,000 if you’re
married filing jointly, and a 3.9% tax on all net self-employment
income over these thresholds).
If you’re a sole proprietor or limited liability company member,
all the income you receive from your business is subject to these
taxes. But there may be a way to reduce the amount of business
income on which such taxes must be paid: Form an S corporation
to own and operate your business.
An S corporation, also called a subchapter S corporation based
on the provision of the Internal Revenue Code, is a regular cor-
poration you establish under your state corporations, law by fil-
ing articles of incorporation with your state’s Secretary of State
or similar official. Your corporation then elects to be taxed as an
S corporation by filing IRS Form 2253 (you should file this within
75 days after you incorporate). S corporations are limited to 100
shareholders (none of whom are nonresident aliens), and there
are some other restrictions as well. In fact, most S corporations
have only one owner-shareholder.

An S corporation is a pass-through entity for tax purposes. This
means that the S corporation ordinarily pays no taxes itself.
Instead, the profits, losses, deductions, and tax credits of the
corporation are passed through the business to the owner’s indi-
vidual tax returns (reported on IRS Schedule E).
When you incorporate your business, if you continue to work in
it, you automatically become an employee of your corporation,
whether full- or part-time. This applies even if you’re the only
shareholder and are not subject to the direction and control
of anybody else. In effect, you wear two hats: You’re both an
owner and an employee of the corporation. As such, you must
pay Social Security and Medicare taxes on any employee salary
your S corporation pays you for your services. You do not, how-
ever, have to pay such tax on distributions from your S corpo-
ration (the net profits that pass through the corporation to you
personally as a shareholder).
The larger your distribution, the less Social Security and Medicare
tax you’ll pay. For example, if your S corporation’s income is
$100,000 and you are paid $65,000 in employee salary, you will
owe the 15.3% self-employment tax on the $65,000 but not on the
remaining $35,000 distributed to you, saving you $5,355 in tax.
S Corp Income
$100,000
Employee Salary
$65,000
-subject to 15.3%
self-employment tax
($9,945)
Shareholder
Distribution (you)
$35,000
-not taxed
(saves $5,355)

Theoretically, if you took no salary at all, you would not owe any
Social Security and Medicare taxes. As you might expect, how-
ever, this is not allowed. The IRS requires S corporation share-
holder-employees to pay themselves a reasonable salary (at
least what other businesses pay for similar services). How much
a reasonable salary amounts to depends on the circumstances
and is subject to debate. But, you should usually pay yourself a
salary of at least one-third to one-half of your S corp’s net profit,
up to the annual Social Security limit ($118,500 in 2015).
However, how much Social Security and Medicare tax you’ll save
with an S corporation depends on how much money your busi-
ness earns. It’s probably not worth forming an S corporation to
save on these taxes if your business earns a profit of less than
$30,000 or so. This is because working as an employee of your
corporation results in extra expenses you don’t have when you’re
a sole proprietor or LLC owner. These include:
• unemployment insurance (remember, you’ll be an employee
of your S corp.)
• workers’ compensation insurance (required in most states
even if you’re the only employee of your S corp.)
• annual corporate franchise taxes or filing fees in most states
($800 per year in California), and costs of preparing a more
complex tax return each year.
You’ll also need to follow certain legal formalities to keep your
corporation in good standing, such as holding an annual meeting
The ability to save on Social Security and Medicare taxes has made
S corporations very popular. They are the second most popular
business form after sole proprietorships.

and keeping corporate records and more complex accounting
records. You can form an S corporation yourself with the help
of many online resources (see, for example, www.nolo.com/
legal-encyclopedia/50-state-guide-forming-corporation.html).
4. You Want to Attract Investors
If you’re looking to attract outside investors who will receive an
equity interest in your business, you’ll probably need to form a
regular C corporation (based on the provision of the tax code
establishing them).
Outside investors often don’t like LLCs because they don’t issue
stock; instead, the owners get “membership interests.” Investors
usually prefer more old-fashioned corporate stock certificates
that they consider tangible evidence of their partial ownership of
the business.
S corporations don’t work well if you want outside investors
because of the many restrictions on share ownership applicable
to them. C corporations are not subject to these restrictions. This
means that with a C corporation, you can have any number of
Pay Social Security
and Medicare Tax
S CORP
100 Shareholders
More expense to
maintain
File IRS
Schedule E
Pays no taxes as
an entity
Can save $ on SS and
Medicare Tax

shareholders, different classes of shares, foreign and U.S. inves-
tors, and shareholders that are corporations or other entities.
To create a C corporation, you simply file articles of incorporation
with your state Secretary of State and don’t file an S corporation
election with the IRS. All corporations automatically begin their lives
as C corporations. They don’t become S corporations until you file
an election to do so with the IRS.
It’s important to understand that, unlike other business forms,
a C corporation is a separate taxpaying entity. C corporations
must pay income taxes on their net income and file their own tax
returns with the IRS. They also have their own income tax rates,
which are lower than individual rates at some income levels. You
don’t pay personal income tax on income your incorporated busi-
ness earns until it is distributed to you (as individual income) in
the form of salary, bonuses, or dividends.
The fact that a C corporation is a separate taxpaying entity has
its good and bad points. On the plus side, a C corporation can
provide its employees with tax-free fringe benefits like health
insurance and fully deduct the cost. On the other hand, a C cor-
poration is not a good choice if you expect your business to lose
money, because you can’t deduct such losses from any other
income you have, such as salary income.
C CORP
Outside
investors
More expenses to
maintain
Pays taxes as an
entity
More costs
deductible

Chapter 5:
Why Tax Deductions
Are So Important
“A wise person should have
money in their head,
but not in their heart.”
— Jonathan Swift

When you’re self-employed, you must pay federal and state taxes
on the net profit you earn from your business activities. However,
you are allowed to deduct your business expenses from your
gross (total) income to determine your net profit subject to tax.
And here’s some good news: When you’re self-employed, almost
everything you spend on your business is deductible from your
business income one way or another, sooner or later. It’s abso-
lutely vital to take all the deductions to which you’re entitled
because they mean money in your pocket.
Most taxpayers, even sophisticated busi-
nesspeople, don’t understand how much
a tax deduction is worth in actual tax
savings. Because a deduction represents
income on which you don’t have to pay
tax, the value of any deduction is the
amount of tax you would have had to pay
on that income had you not deducted
it. So, a deduction of $1,000 won’t save
you $1,000; it will save you whatever you
would otherwise have had to pay as tax
on that $1,000 of income.
Federal and State Income Taxes
To determine how much income tax a deduction will save you,
Chapter Five:
Why Tax Deductions Are So Important

you must first figure out your top income tax bracket. The United
States has a progressive income tax system for individual taxpay-
ers with seven different tax rates (called tax brackets), ranging
from 10% of taxable income to 39.6% as per the chart below.
The higher your income, the higher your top tax rate.
You move from one bracket to the next only when your tax-
able income exceeds the bracket amount. For example, if you
are a single taxpayer, you pay 10% income tax on all your tax-
able income up to $9,225. If your taxable income exceeds that
amount, the next tax rate (15%) applies to all of your income
over $9,225—but the 10% rate still applies to the first $9,225.
If your income exceeds the 15% bracket amount, the next tax
rate (25%) applies to the excess amount, and so on until the top
bracket of 39.6% is reached.
The tax bracket in which the last dollar you earn for the year falls
is called your “marginal tax bracket.” For example, if you have
$75,000 in taxable income, your marginal tax bracket is 25%. To
determine how much federal income tax a deduction will save
you, multiply the amount of the deduction by your marginal tax
10%
>$9,225 $37,450
$75,000
Your marginal
Tax Bracket
For a Single Taxpayer:
...39.6%
$90,750 $189,301
15% 25% 28%

bracket. If your marginal tax bracket is 25%, you will save 25¢ in
federal income taxes for every dollar you are able to claim as a
deductible business expense (25% × $1 = 25¢). This calculation
is only approximate, because an additional deduction may move
you from one tax bracket to another and thus lower your mar-
ginal tax rate.
You can also deduct your business expenses from any state
income tax you must pay. The average state income tax rate is
about 6%, although seven states (Alaska, Florida, Nevada, South
Dakota, Texas, Washington, and Wyoming) don’t have an income
tax, and New Hampshire taxes only gambling winnings, dividends,
and interest. You can find a list of all state income tax rates at the
Federation of Tax Administrators website, at www.taxadmin.org.
2015 Federal Personal Income Tax Brackets
Tax Bracket Income if Single
Income if Married
Filing Jointly
10% Up t0 $9,225 Up to $18,451
15% $9,225 - $37, 450 $18,451 - $74,900
25% $37,451 - $90,750 $74,901 - $151,200
28% $90,751 - $189,300 $151,201 - $230,450
33% $189,301 - $411,500 $230,451 - $411,500
35% $411,501 - $413,200 $411,501 - $464,850
39.6% Over $413,200 Over $464,850

Self-Employment Taxes
By reducing your business income, business deductions reduce
your self-employment taxes—the taxes you pay to support Social
Security and Medicare. This makes such deductions doubly
valuable. These taxes consist of a flat 15.3% combined Social
Security and Medicare tax on your first $118,500 in net self-em-
ployment income (in 2015). If you earn more than that amount,
you must pay additional Medicare taxes (a 2.9% tax on your
income up to $200,000 if you’re single or $250,000 if you’re
married filing jointly, and a 3.9% tax on all net self-employment
income over these thresholds).
Total Tax Savings
When you add up your savings in federal, state, and self-employ-
ment taxes, you can see the true value of a business tax deduc-
tion. For example, if you make $75,000, a business deduction
can be worth as much as 25% (in federal income tax) + 15.3% (in
self-employment taxes) + 6% (in state taxes—depending on which
state you live in). That adds up to a whopping 46.3% savings. For
example, if you buy a $1,000 computer for your business and you
deduct the expense, you save about $463 in taxes. In effect, the
Business deductions
reduce your
self-employment
taxes.

government is paying for almost half of your business expenses.
This is why it’s so important to know all the business deductions
you are entitled to take—and to take advantage of every one.
Don’t buy stuff just to get a tax deduction! Although tax deduc-
tions can be worth a lot, it doesn’t make sense to buy something
you don’t need just to get a deduction. After all, you still have
to pay for the item, and the tax deduction you get in return will
only cover a portion of the cost. If you buy a $1,000 computer,
you’ll probably be able to deduct less than half of the cost. That
means you’re still out more than $500—money you’ve spent for
something you don’t need. On the other hand, if you really do
need a computer, the deduction you’re entitled to is like found
money, and it may help you buy a better computer than you
could otherwise afford.

Chapter 6:
Deducting Your
Business Operating
Expenses
“A penny saved is
a penny earned.”
— Benjamin Franklin

This chapter covers the basic rules for deducting business oper-
ating expenses—the bread and butter expenses virtually every
business incurs for things like rent, supplies, and salaries. If you
don’t maintain an inventory or buy expensive equipment, these
day-to-day costs will probably be your largest category of busi-
ness expenses (and your largest source of deductions).
Requirements for Deducting Operating Expenses
There are so many different kinds of business operating
expenses that the tax code couldn’t possibly list them all.
Instead, if you want to deduct an item as a business operating
expense, you must make sure the expenditure meets certain
requirements. If it does, it will qualify as a deductible business
operating expense. To qualify, the expense must be:
• ordinary and necessary—the expense is common, helpful
and appropriate for your business (it doesn’t have to
be indispensable)
• a current expense—the expense is for an item that will bene-
fit your business for less than one year
• directly related to your business—thus, you cannot deduct
personal expenses, and
• reasonable in amount—there are no dollar limits, and an
expense is reasonable unless there are more economical
and practical ways to achieve the same result. (IRC § 162)
Chapter Six:
Deducting Your Business
Operating Expenses

Common Operating Expenses
Examples of common deductible operating expenses for small
businesses include:
• rent for an outside office
• employee salaries and benefits
• equipment rental
• business websites
• legal and accounting fees
• car and truck expenses
• travel expenses
• meal and entertainment expenses
• supplies and materials
• publications
• subscriptions
• repair and maintenance expenses
• business taxes
• interest on business loans
• licenses
• banking fees
• advertising costs
• home office expenses
• business-related education expenses
• postage
• professional association dues
• business liability and property insurance

• health insurance for employees
• office utilities, and
• software used for business.
Operating Expenses That Are Not Deductible
Even though they might be ordinary and necessary, some types
of operating expenses are not deductible under any circum-
stances. These nondeductible expenses include:
• fines and penalties paid to the government for violation of
any law—for example, tax penalties, parking tickets, or fines
for violating city housing codes (IRC § 162(f))
• illegal bribes or kickbacks to private parties or government
officials (IRC § 162(c))
• lobbying expenses or political contributions; however, a
business may deduct up to $2,000 per year in expenses to
influence local legislation (state, county, or city), not includ-
ing the expense of hiring a professional lobbyist (such lobby-
ist expenses are not deductible)
• two-thirds of any damages paid for violation of the federal
antitrust laws (IRC § 162(g))
• bar or professional examination fees
• charitable donations by any business other than a C corpo-
ration (these donations are only deductible as
personal expenses)
• country club, social club, or athletic club dues, and
• federal income taxes you pay on your business income.
In some cases, this is because Congress has declared that it would be morally
wrong or otherwise contrary to sound public policy to allow people to deduct
these costs. In other cases, Congress simply doesn’t want to allow the deduction.

Chapter 7:
Deductions When
You Drive for
Business
“It takes as much energy to
wish as it does to plan.”
— Thomas Edison

This chapter provides a brief overview of tax deductions when
you drive your car or other vehicle on local business trips. For a
detailed discussion of all aspects of this deduction, see MileIQ’s
Ultimate Guide to Mileage Tracking in the United States.
When Can You Deduct Local Travel?
You can only deduct local trips that are for business—that is,
travel to a business location. This is any place where you perform
business-related tasks, such as:
• the place where you have your principal place of business,
including a home office
• other places where you work, including temporary job sites
• places where you meet with clients or customers
• the bank where you do business banking
• a local college where you take work-related classes
• the store where you buy business supplies, or
• the place where you keep business inventory.
However, there is a big limitation on your deductions for local
travel: You can only deduct travel from one business location to
another business location. You may not deduct the cost of trav-
eling from your home to a regular work location; such commuting
is considered a nondeductible personal expense by the IRS.
Chapter Seven:
Deductions When You Drive
for Business

Because commuting is not deductible, where your business
office or other principal workplace is located has a big effect on
the amount you can deduct for business trips. You will get the
fewest deductions if you work solely in an outside office. You lose
out on many potential business miles this way because you can’t
deduct any trips between your home and your office.
On the other hand, you will maximize your local travel deductions
if you have a tax-deductible home office that qualifies as your
principal place of business. When you have a home office, you can
deduct the cost of any trips you make from home to another busi-
ness location. In short, the commuting rule won’t apply. It’s easy
for most self-employed people to have a tax-deductible home
office. For details, see Chapter 11, Deducting Your Home Office.
There is one significant exception to the commuting rule: If you
have a regular place of business, travel between your home and
a temporary work location is not considered commuting and is
therefore deductible. A temporary work location is any place
where you realistically expect to work less than one year. If you
don’t have a regular office, you can deduct the cost of going from
Keep accurate
records of your
travel for work with
a mileage app.

home to a temporary work location only if the temporary work
location is outside of your metropolitan area.
How Much Can You Deduct for Local Travel?
When you use your car, SUV, minivan, van, or pick-up for local
business travel, there are two ways to calculate your deduction:
the standard mileage method and the actual expense method.
Standard Mileage Method
With the standard mileage rate, you deduct a specified number
of cents for every business mile you drive. The IRS sets the stan-
dard mileage rate each year. For 2015, the rate is 57.5¢ per mile.
To figure out your deduction, simply multiply your business miles
by the standard mileage rate. For example, if you drive 10,000
miles for business during 2015, you’ll get a $5,750 deduction.
As you can see, the standard mileage rate is very easy to use. All
you need do is keep track of the business miles you drive each
year. That’s why it’s the most popular of the two methods. You
must use the standard mileage rate the first year you use a car
for business. If you don’t, you are forever foreclosed from using
that method for that car. If you use the standard mileage rate
the first year, you can switch to the actual expense method in a
later year, and then switch back and forth between the two meth-
ods after that, subject to certain restrictions. For this reason, if
Mileage x Standard Rate 2015 = Mileage Deduction
10,000
miles
57.5
cents/mile
$5,750
deduction

you’re not sure which method you want to use, it’s a good idea
to use the standard mileage rate the first year you use the car
for business. This leaves all of your options open for later years.
However, if you use the standard mileage rate method for a car
you lease, you must use that method for the entire lease period
(including renewals).
Actual Expense Method
As the name implies, when you use the actual expense method,
you deduct the actual cost of operating your car when you drive
for business, including:
For example, if you purchase for $65,000 an over 6,000 pound vehicle and
you use it 100% for business during 2015, you’d be able to deduct $60,660
of the cost in 2015. If you bought a $65,000 vehicle that weighed less than
6,000 pounds, your total first year deduction would be limited to $8,160.
gas and oil
repairs and maintenance
car repair tools
license fees
parking fees for business trips
registration fees
tires
insurance
car washing
lease payments
towing charges
auto club dues
depreciation*
*subject to annual limits
The actual expense method requires a lot more recordkeeping
than the standard mileage method, since you need to keep track
of your operating expenses as well as your business mileage
during the year. However, it will give you a larger deduction than
the standard mileage rate if you drive a car that is more expen-
sive than average to operate.
Using the actual expense method can also pay off if you have a
vehicle that weighs more than 6,000 pounds. The annual limits
on depreciation don’t apply to such vehicles; as a result, you can
depreciate most of the cost of such a vehicle in a single year.

Good Recordkeeping Is the Key to This Deduction
The business mileage deduction is one of the most closely scru-
tinized deductions by the IRS. This is because the IRS knows
that many people exaggerate their mileage. Many more fail to
keep good records (or any records) of their business mileage
and make wild guesses about how much they drove for business
when it comes time to do their taxes.
Estimates of your business mileage don’t cut it with the IRS. You
are supposed to keep contemporaneous records of your busi-
ness driving such that records are created each day you drive for
business (or soon thereafter) at least weekly.
For all your business-related drives, you must keep a record of the:
• time and date of the drive
• total distance of the drive
• destination of the drive (although not strictly required, it’s
wise to record the start and stop location for more thorough
records), and
• business purpose of the drive.
The IRS also wants to know the total number of miles you drove
during the year for business, commuting, and personal driving
other than commuting.
The IRS permits you to use any reliable method to keep such
records. You can use a paper mileage logbook that you keep in
your car, an electronic spreadsheet template, or a mileage
tracking application.

Chapter 8:
Deductions When You
Travel Out of Town for
Business
“Opportunity is missed by
most people because
it is dressed in overalls
and looks like work.”
— Thomas Edison

Do you ever travel out of town for your business? If so, most of
the expenses you incur are deductible. This can greatly reduce
the effective cost of your business trips.
When Is a Trip Deductible?
A trip is deductible as a business expense only when you travel
away from your tax home overnight for your business. You don’t
have to travel any set distance. However, you must travel outside
your city limits. If you don’t live in a city, you must go outside the
general area where your business is located. Also, you must stay
away overnight or at least long enough to require a stop for sleep
or rest. You cannot satisfy the rest requirement by merely nap-
ping in your car.
Your trip must be primarily for business to be deductible.
Examples of business purposes include:
• finding new customers or markets for your products
or services
• dealing with existing customers or clients
• learning new skills to help in your business
• contacting people who could help your business, such as
potential investors, or
• checking out what the competition is doing.
Chapter Eight:
Deductions When You Travel Out of
Town for Business

What Travel Expenses are Deductible?
Subject to the limits noted below, virtually all of your business
travel expenses are deductible. These fall into two broad catego-
ries: your transportation expenses and the expenses you incur at
your destination.
Transportation expenses are the costs of getting to and from
your destination—for example:
• fares for airplanes, trains, or buses
• driving expenses, including car rentals
• shipping costs for your personal luggage or samples, dis-
plays, or other things you need for your business, and
• 50% of meals and beverage expenses, and 100% of lodging
expenses you incur while en route to your final destination.
If you drive your personal car to your destination, you may
deduct your costs by using either the standard mileage rate or
your actual expenses. You may also deduct your mileage while at
your destination.

You may deduct 50% of
entertainment expenses
if you incur
them for
business
purposes.
You may also deduct the expenses you incur to stay alive
(food and lodging) and do business while at your destination.
Destination expenses include:
• hotel or other lodging expenses for business days
• 50% of meal and beverage expenses
• taxi, public transportation, and car rental expenses at
your destination
• telephone, Internet, and fax expenses
• computer rental fees
• laundry and dry cleaning expenses, and
• tips you pay on any of the other costs.
How Much Can You Deduct?
If you spend all of your time at your destination on business,
you may deduct 100% of your expenses (except meal expenses,
which are only 50% deductible—see below). However, things are
more complicated if you mix business and pleasure. Different
rules apply to your transportation expenses and the expenses
you incur while at your destination (“destination expenses”).
Travel within the United States
Business travel within the United States is subject to an all-
or-nothing rule: You may deduct 100% of your transporta-
tion expenses only if you spend more than half of your time on
You can’t deduct entertainment expenses for activities that
you attend alone, because this solo entertainment obviously
wouldn’t be for business purposes. If you want to deduct the
cost of a nightclub or ball game while on the road, be sure to
take a business associate along.

business activities while at your destination. If you spend more
time on personal activities than on business, you get no transporta-
tion deduction. You may also deduct the destination expenses you
incur on the days you do business. Expenses incurred on personal
days at your destination are nondeductible personal expenses.
If your trip is primarily a vacation—that is, you spend more than
half of your time on personal activities—the entire cost of the trip
is a nondeductible personal expense.
Travel outside the United States
The rules for deducting your transportation expenses depend on
how long you stay at your destination.
If you travel outside the United
States for no more than seven
consecutive days, you can deduct
100% of your airfare or other
transportation expenses as long
as you spend part of the time on
business. You can spend a major-
ity of your time on personal activities as long as you spend at
least some time on business. You may also deduct the destina-
tion expenses you incur on the days you do business.
The IRS does not want to subsidize lengthy foreign vacations, so
more stringent rules apply if your foreign trip lasts more than one
week. For these longer trips, the magic number is 75%. If you
spend more than 75% of your time on business at your foreign
destination, you can deduct what it would have cost to make the
trip if you had not engaged in any personal activities. This means

you may deduct 100% of your airfare or other transportation
expenses, plus your living expenses while you were on business
and any other business-related expenses. If you spend more
than 50%—but less than 75%—of your time on business, you can
deduct only the business percentage of your transportation and
other costs. If you spend less than 51% of your time on business
during foreign travel that lasts more than seven days, you cannot
deduct any of your costs.
50% Limit on Meal Expenses
The IRS figures that whether you’re at home or away on a busi-
ness trip, you have to eat. Because home meals ordinarily
aren’t deductible, the IRS won’t let you deduct all of your food
expenses while traveling.
Instead, you can deduct only 50% of your meal expenses
while on a business trip. You can deduct 50% of your actual
meal expenses, or use the standard meal allowance—a specific
amount you’re permitted to deduct each day no matter how
much you actually spend.
No deductions
<51%
Deduct all travel and
living expenses
75%
Deduct percentage of
business from travel and
living expenses
50-75%

The amount of the standard meal allowance varies with your des-
tination, but is fairly modest. In 2015, the daily rates for domestic
travel ranged from $46 per day for travel in the least expensive
areas to up to $71 in high-cost areas, which include most major
cities. The standard meal allowance is revised each year.
You can find the current rates for travel within the
United States at www.gsa.gov (look for the link to
“Per Diem Rates”) or in IRS Publication 1542.
The rates for foreign travel are set by the
U.S. State Department and can be found at
www.state.gov.

Chapter 9:
Deducting Business
Meals and Entertainment
“Nobody is in business for
fun, but that does not
mean there cannot be
fun in business.”
—Leo Burnett

Business isn’t done only in an office. Some of your most import-
ant business meetings, client contacts, and marketing efforts
may take place at restaurants, golf courses, or sporting events.
The tax law recognizes this and permits you to deduct part of the
cost of business-related entertainment. However, because many
taxpayers have abused this deduction in the past, the IRS has
imposed strict rules limiting the types of entertainment expenses
you can deduct and the size of the deduction.
When Can You Deduct Meals and Entertainment?
Deductible entertainment expenses can include the cost of:
• dining out
• going to a nightclub
• attending a sporting event
• going to a concert, a movie, or
the theater
• visiting a vacation spot (a ski area
or beach resort, for example), or
• taking a hunting, yachting, or
fishing trip.
Chapter Nine:
Deducting Business Meals
and Entertainment

You must be with one or more people who can benefit your busi-
ness in some way to claim an entertainment expense. This could
include current or potential:
• customers
• clients
• suppliers
• employees
• independent contractors
• agents
• partners, or
• professional advisers.
This list includes almost anyone you’re likely to meet for busi-
ness reasons. Although you can invite family members or friends
along, you can’t deduct the costs of entertaining them, except in
certain limited situations.
In the past, you could deduct entertainment expenses even if busi-
ness was never discussed. For example, if you took a client to a
restaurant, you could deduct the cost even if you spent the whole
time drinking martinis and talking about sports. This is no longer
the case. To deduct an entertainment expense, you must discuss
business either before, during, or after the entertainment.
Discussing Business During Entertainment
You’re entitled to deduct part of the cost of entertaining a client or
another business associate if you have an active business discus-
sion during the entertainment aimed at obtaining income or other
benefits. You don’t have to spend the entire time talking business,
but the main motive of the meal or other event must be business.

The IRS will not believe you discussed business if the entertain-
ment occurred in a place where it is difficult or impossible to talk
business because of distractions (for example, at a nightclub,
theater, or sporting event, or at an essentially social gathering,
such as a cocktail party).
On the other hand, the IRS will presume you discussed business
if a meal or entertainment took place in a clear business setting,
such as a catered lunch at your office.
Example: Ivan, a self-employed consultant, takes a prospective client
to a restaurant where they discuss and finalize the terms of a contract
for Ivan’s consulting services. Ivan can deduct the cost of the meal as
an entertainment expense.
Discussing Business Before or After Entertainment
You are also entitled to deduct the full expense of an entertain-
ment event if you have a substantial business discussion with a
client or other business associate before or after it. This requires
that you have a meeting, negotiation, or other business trans-
action designed to help you get income or some other specific
business benefit.
Generally, the entertainment should occur on the same day as
the business discussion. However, if your business guests are
from out of town, the entertainment can occur the day before or
the day after.
The duration of the entertainment doesn’t have to be shorter than
your business discussions, but you can’t spend only a small fraction

of your total time on business. You can deduct entertainment
expenses at places such as nightclubs, sporting events, or theaters.
How Much Can You Deduct?
You can deduct only entertainment expenses you paid. If a client
picks up the tab, you obviously get no deduction. If you split the
expense, you may deduct only what you paid.
Moreover, you’re allowed to deduct only 50% of your expenses.
For example, if you spend $50 for a meal in a restaurant, you can
only deduct $25. However, you must keep track of your spend-
ing and report the entire amount on your tax return. The cost of
transportation to and from a business meal or other entertain-
ment is not subject to the 50% limit.
You can deduct the cost of entertaining your spouse and the cli-
ent’s spouse only if it’s impractical to entertain the client without
his or her spouse and your spouse joins the party because the
client’s spouse is also attending.
If you entertain a client or another business associate while away
from home on business, you can deduct the cost either as a
travel expense or an entertainment expense, but not as both.
Example: Following lengthy contract negotiations at a prospective
client’s office, you take the client to a baseball game to unwind.
The cost of the tickets is a deductible business expense.

Expenses You Can’t Deduct
There are certain expenses that you are prohibited from deduct-
ing as entertainment: You may not deduct the cost of buying,
leasing, or maintaining an entertainment facility such as a yacht,
swimming pool, tennis court, hunting camp, fishing lodge, bowling
alley, car, airplane, hotel suite, apartment, or home in a vacation
resort. These entertainment facilities are not considered deduct-
ible business assets.
You also may not deduct the cost of entertaining people who
are not business associates. If you entertain business and non-
business guests at an event, you must divide your entertainment
expenses between the two and deduct only the business part.
You cannot deduct dues paid to country clubs, golf and athletic
clubs, airline clubs, hotel clubs, or clubs operated to provide
members with meals. However, you can deduct other expenses
you incur to entertain a business associate at a club.

Reimbursed Expenses
If a client or customer reimburses you for entertainment
expenses, you don’t need to count the reimbursement that you
receive as income as long as you give the client an adequate
accounting of your expenses and comply with the accountable
plan rules. Basically, this requires that you submit all of your
documentation to the client in a timely manner and return any
excess payments. The client gets to deduct 50% of the expenses
and you get 100% of your expenses paid for by somebody
else. This is a lot better then getting only a 50% entertainment
expense deduction. The reimbursement should not be listed by
the client on any Form 1099-MISC that they are typically required
to send to the IRS to show the amount paid to you for your ser-
vices during the year.

Chapter 10:
Deducting
Equipment and
Other Business Assets
“The successful warrior
is the average man,
with laser-like focus.”
—Bruce Lee

This chapter is about deducting the cost of long-term assets you
use in your business. These are assets with a useful life of more
than one year. This typically includes items such as buildings,
equipment, vehicles, books, office furniture, machinery, comput-
ers and other electronics.
One of the nice things about having a business is that you can
deduct the money you spend for such items. Moreover, you can
take a full deduction whether you pay cash for an asset or buy
on credit. However, special rules apply to deducting long-term
assets. If you qualify for the de minimis safe harbor or Section
179 deductions discussed below, you can deduct the entire cost
of these items in the year you pay for them. If not, you have to
deduct the cost a portion at a time over a period of years through
a process called depreciation.
Deducting Inexpensive Property in a Single Year
What the IRS calls the “de minimis safe harbor” went into effect
in 2014. You may use this IRS regulation to currently deduct the
cost of personal property items you use in your business that
cost up to $500 a piece. This can result in a substantial deduc-
tion. Indeed, you may be able to currently deduct in one year
all the long-term property you buy for your business by taking
advantage of this deduction alone.
Chapter Ten:
Deducting Equipment and Other
Business Assets

To use this deduction, you must file an annual election with your
tax return—something that is easy to do. When you make this
election, it applies to all expenses you incur that qualify for the
de minimis safe harbor. You cannot pick and choose which items
you want to include.
You may use the de minimis safe harbor only for property whose
cost does not exceed $500 per invoice, or $500 per item as sub-
stantiated by the invoice. If the cost exceeds $500 per invoice (or
item), no part of the cost may be deducted by using the de mini-
mis safe harbor.
The de minimis safe harbor can’t be used to deduct the cost of
land, inventory (items held for sale to customers), certain spare
parts for machinery or other equipment, or amounts that you pay
for property that you produce or acquire for resale.
Example: Alice purchases the following items for her consulting business from a local office
supply store:
Alice’s total bill is $2,650. However, she applies the de minimis safe harbor rule item-by-item
as shown on the invoice. Each item is less than the $500 de minimis safe harbor limit except
the desk. Thus, Alice may immediately deduct $1,650 of the total using the safe harbor. She
can’t use the safe harbor to deduct the $1,000 cost of the desk. Instead, she may deduct the
desk in one year using Section 179 or depreciate the cost a portion at a time over six years as
described below.
Printer $250
Paper Shredder $100
Tablets (2) $800
Office Chair $500
Office Desk $1000
Total $2650
$1650 eligible for
de minimis safe harbor
Deduct using
Section 179 or depreciate

Section 179 Deduction
If you purchase an item for your business that costs more than
$500, you may still be able to deduct the full cost in one year
using a provision of the tax code called Section 179 (based on the
section of the tax code establishing the deduction). This is also
called “first-year expensing” or “Section 179 expensing.”
You can use Section 179 to deduct the cost of tangible personal
property you use for your business, such as computers, furni-
ture, and equipment. However, you can’t use Section 179 for land,
buildings, or intangible personal property, such as patents, copy-
rights, and trademarks.
If you use property both for business and personal purposes, you
may deduct it under Section 179 only if you use it for business
purposes more than half the time. You must reduce the amount
of your deduction by the percentage of personal use. You’ll need
to keep records showing your business use of such property. If
you use an item for business less than half the time, you must
depreciate it as explained in “Depreciation,” below.
Annual Deduction Limit
There is a limit on the total amount of business property
expenses you can deduct each year using Section 179. The limit
was $500,000 in 2014. The $500,000 limit automatically expired
on January 1, 2015 and was reduced to $25,000 on January 1,
2015. However, it is expected that Congress will act to increase
Example: Ginger buys an $8,000 3D copy machine for her industrial design
business. She can use Section 179 to deduct the entire $8,000 expense from
her taxes for the year.

the 2015 limit back to $500,000, something it has done the last
several years. This dollar limit applies to all of your businesses
together, not to each business you own and run.
It’s up to you to decide how much you want to deduct. But you
won’t lose out on the remainder; you can depreciate any cost you
do not deduct under Section 179.
Annual Profit Limit on Section 179 Deduction
There is a significant limitation on the Section 179 deduction
that can greatly limit its use by many small businesses: You
can’t use Section 179 to deduct more in one year than the total
of your profit from all of your businesses and your salary if you
have a job in addition to your business. If you’re married and file
a joint tax return, you can include your spouse’s salary and busi-
ness income in this total as well. But you can’t count investment
income (for example, interest you earn on your savings). Thus,
if you have a money-losing business and no other income, you
might not be able to use Section 179 at all.

Minimum Period of Business Use
When you deduct an asset under Section 179, you must con-
tinue to use it in your business at least 50% of the time for as
many years as it would have been depreciated had you not used
Section 179. For example, if you use Section 179 for a computer,
you must use it for business at least 50% of the time for five
years, because computers have a five-year depreciation period. If
you don’t meet these rules, you’ll have to report as income part
of the deduction you took under Section 179 in the prior year.
This is called “recapture.”
Depreciation
Most small business owners are able to deduct all or most of
their equipment and other asset purchases in one year using the
de minimis safe harbor and/or Section 179 expensing. However,
you must use depreciation instead in the following cases:
• You use an item or property less
than 51% of the time for business.
• The property is a building or
building component.
• You financed the purchase with
a trade-in (the value of the
trade-in must be depreciated).
• The item is an intangible asset,
such as a patent, copyright, or
trademark.
• You bought the item from a relative.
• You inherited or received the
property as a gift.

Depreciation involves deducting the cost of a business asset a
portion at a time over a period of years. This means it will take
you much longer to get your full deduction than under Section
179 or the de minimis safe harbor.
If you use property for both business
and personal purposes, you can take
depreciation only for the business
use of the asset. Unlike the Section
179 deduction, however, you don’t
have to use an item more than half
the time for business to depreciate it.
Depreciation Period
The depreciation period—called the “recovery period” by the IRS—
begins when you start using the asset and lasts for the entire
estimated useful life of the asset. The tax code has assigned an
estimated useful life for all types of business assets, ranging from
three to 39 years. Most of the assets you buy for your business will
probably have an estimated useful life of five to seven years. You
are free to continue using property after its estimated useful life
expires, but you can’t deduct any more depreciation.
Calculating Depreciation
There are several different systems you can use to calculate
depreciation. Most small businesses use accelerated deprecia-
tion which provides larger depreciation deductions in the earlier
years and smaller ones later on. For example, the double declin-
ing-balance method starts out by giving you double the deduc-
tion you’d get for the first full year if you depreciated the same
amount every year. This is the fastest depreciation you can get.

50% Bonus Depreciation
Starting in 2008, businesses have been allowed to take a very
large 50% “bonus depreciation” deduction—that is, they could
deduct in one year half of the cost of new personal property
they buy for their business. The remaining cost of the property
must be depreciated under the normal rules. Bonus depreci-
ation expired at the end of 2014, but it is widely expected that
Congress will extend it through 2015 and likely beyond.
2015 $2,000
2016 $3,200
2017 $1,920
2018 $1,150
2019 $1,150
2020 $580
Total $10,000
Example: Sally buys a $10,000 computer system for her business in 2015. It has a useful
life of five years. She depreciates the asset over six years using the double declining-balance
method. Her annual depreciation deductions are as follows:
Example: If Sally from the previous example elects to use bonus depreciation
for her $10,000 computer system, she may deduct $5,000 of the cost the
first year and then depreciate the remaining $5,000 over six years. This gives
Sally a total $6,000 deduction for the first year instead of $2,000.

Listed Property
The IRS imposes special rules on certain items that can easily
be used for personal as well as business purposes. These items,
called “listed property,” include:
• cars, boats, airplanes, and other vehicles
• computers, and
• any other property generally used for entertainment, recre-
ation, or amusement (including photographic, communica-
tion, and video recording equipment).
The IRS fears that taxpayers might use listed property items for
personal reasons but claim business deductions for them. For
this reason, you’re required to document your business use of
listed property. You can satisfy this requirement by keeping a log-
book showing when and how the property is used.
If you use listed property for business more than 50% of the
time, you can depreciate it just like any other property. However,
if you use it 50% or less of the time for business, you are not
allowed to use accelerated depreciation to deduct the cost.
Instead, you must depreciate an equal amount each year (also
know as “straight-line depreciation”). If you start out using accel-
erated depreciation and your business use drops to 50% or less,
you have to switch to the straight-line method and pay taxes on
the benefits of the prior years of accelerated depreciation.
For more information about depreciation, Sec-
tion 179, and the de minimis safe harbor, see
IRS Publication 946, How to Depreciate Property.

Chapter 11:
Deducting Your
Home Office
“Carpe per diem–
seize the check.”
—Robin Williams

If, like many self-employed people, you elect to work from home,
you may qualify to deduct your home office expenses. This is so
whether you own or rent your home. Although this tax deduction
is commonly called the “home office deduction,” it is not limited
to home offices. You can also take it if, for example, you have a
workshop or studio at home.
Your Home Office Can be a Great Deduction
Because some people claim that the home office deduction is
an audit flag for the IRS, many self-employed people who qualify
for it are afraid to take it. This is a big mistake. First of all, the IRS
denies that taking the home office deduction increases your audit
risk, and there is no empirical evidence that it does so. Also, you
have nothing to fear from an audit if you’re entitled to the deduc-
tion. Second of all, the home office deduction can be one of your
most valuable deductions. This is particularly likely if you’re a
renter, because it enables you to deduct a portion of your rent—a
substantial expense that is ordinarily not deductible.
Taking the home office deduction can also greatly increase your
deductions for business driving. When you have a home office
that qualifies as a principal place of business, you have no com-
muting (which is not deductible). This means you get a mileage
deduction every time you leave your home to drive to another
business location.
Chapter Eleven:
Deducting Your Home Office

Requirements to Qualify for the Home Office Deduction
The fact that you use a space in your home for your business
doesn’t necessarily mean you qualify for the home office deduc-
tion. There are several strict requirements you must satisfy to
take this deduction.
Threshold requirement: regular and exclusive business use
The threshold requirement for taking the home office deduction
is that you regularly use part of your home exclusively for a trade
or business. Unfortunately, the IRS doesn’t offer a clear definition
of “regular use.” The only guidance the agency offers is that you
must use a portion of your home for business on a continuing
basis, not just for occasional or incidental business. You’ll likely
satisfy this test if you use your home office a few hours each day.
“Exclusive use” means that you use a portion of your home only
for business. If you use part of your home as your business office
and also use that part for personal purposes, you cannot meet
the test of exclusive use and cannot take the home office deduc-
tion. You needn’t devote an entirely separate room in your home
to your business. But some part of the room must be used exclu-
sively for business.
“Exclusive Use”
You use a portion
of your home only
for business
“Regular Use”
You use a portion
of your home on a
continuing basis

Your Home Office Is a Principal Place of Business
If you use a portion of your home regularly and exclusively for
business, you’ll qualify for the home office deduction if you use
your home as your principal place of business. Most self-employed
people qualify for the home office deduction on this basis.
If you do most of your work at home: If, like many self-employed
people, you do all or most of your work in your home office, your
home is your principal place of business. You should have no trou-
ble qualifying for the home office deduction. This would be the
case, for example, for writers who do most of their writing at home
or telemarketers who make most of their sales calls from home.
If you do only administrative work at home: Of course, many
people who work for themselves spend the bulk of their time
working away from home. This is the case, for example, for:
• self-employed drivers who work for
car services like Uber or Lyft
• building contractors who work primarily
on building sites
• traveling salespeople who visit clients
at their places of business, and
• house painters, gardeners, and home
repair people who work primarily in their
customers’ homes.
Fortunately, even if you work primarily outside your home, your
home office will qualify as your principal place of business if both
of the following are true:

• you use the office to conduct administrative or management
activities for your business, and
• there is no other fixed location where you conduct
such activities.
What this means is that to qualify for the home office deduction,
your home office does not need to be the place where you generate
most of your business income. It’s sufficient that you use it regularly
to administer or manage your business (for example, to keep your
books, schedule appointments, do research, and order supplies).
As long as you have no other fixed location where you regularly do
such things (an outside office), you can take the deduction.
You don’t have to personally perform at home all the administra-
tive or management activities your business requires to qualify
for the home office deduction. Your home office can qualify for
the deduction even if:
• You have others conduct your administrative or management
activities at locations other than your home (for example,
another company does your billing from its place of business).
• You conduct administrative or management activities at places
that are not fixed locations for your business, such as in a car
or a hotel room.
• You occasionally conduct minimal administrative or manage-
ment activities at a fixed location outside your home, such as
your outside office.
Example: Sally, a handyperson, performs home repair
work for clients in their homes. She also has a home office
that she uses regularly and exclusively to keep her books,
arrange appointments, and order supplies.
Sally is
entitled to a
home office
deduction.

Other Ways to Qualify for the Home Office Deduction
Even if your home doesn’t qualify as your principal place of busi-
ness, you can still take the home office deduction if:
• you regularly meet clients or customers in your home office
• you have a separate freestanding structure, such as a stu-
dio, garage, or barn, that you exclusively and regularly for
your business, or
• you’re in the business of selling retail or wholesale products
and you store inventory or product samples at home.
Amount of Deduction
There are two ways to calculate the home office deduction: You
can use the standard method or a new simplified method.
Standard Method
To figure out the amount of the home office deduction using the
standard method, you need to determine what percentage of
your home you use for business. To do this, divide the square
footage of your home office by the total square footage of your
home. For example, if your home is 1,600 square feet and you
use 400 square feet for your home office, your home office per-
centage is 25%. If all the rooms in your home are about the
same size, you can figure the business portion by dividing the
number of rooms used for business by the number of rooms in
the home. For example, if you use one room in a five-room house
for business, your home office percentage is 20%.

When you use the standard method, your home office deduction
consists of many different expenses that are added together.
First, you are entitled to deduct your home office percentage of:
• your rent, if you rent your home, or
• depreciation, mortgage interest, and property taxes if you
own your home.
You may also deduct your home office percentage of other
expenses you incur to keep up your entire home. The IRS calls
these indirect expenses. They include:
• utility expenses for electricity, gas, heat, and trash removal
• homeowner’s or renter’s insurance
• home maintenance expenses that benefit your entire home,
including your home office (for example, roof and furnace
repairs or exterior painting)
• condominium association fees
Home Office Living Room
Bed Room
Kitchen
Bathroom
or=
400 sq ft
1/5 rooms = 20%
25%1600 sq ft

• snow removal expenses
• casualty losses if your home is damaged (for example, in a
storm), and
• security system costs.
You may also deduct the entire cost of expenses solely for your
home office. The IRS calls these direct expenses. They include, for
example, the cost of painting your home office or paying someone
to clean it. If you pay a housekeeper to clean your entire house,
you may deduct your business use percentage of the expense.
Be sure to keep copies of all of your bills and receipts for home
office expenses.
Simplified Method
You have the option of using a much simpler method to calculate
your home office deduction. Using this method, you just deduct
$5 for every square foot of your home office. All you need to do is
get out your measuring tape. For example, if your home office is
200 square feet, you’ll get a $1,000 home office deduction. That’s
all there is to it. You need not figure out what percentage of your
home your office occupies. You also don’t need to keep records of
your direct or indirect home office expenses, such as utilities, rent,
mortgage payments, real estate taxes, or casualty losses. These
Example: Jean rents a 1,600-square-foot apartment and uses a 400-square-
foot room as a home office for her consulting business. Her percentage of
business use is 25% (400 ÷ 1,600). She pays $12,000 in annual rent and has
a $1,200 utility bill for the year. She also spent $200 to paint her home office.
She is entitled to deduct 25% of her rent and utilities ($3,300) plus the entire
cost of painting her office, for a total home office deduction of $3,500.

expenses aren’t deductible when you use the simplified method—
nor do you get a depreciation deduction for your home office.
Sounds great, but what’s the catch? The catch is that when you
use the simplified method, your home office deduction is capped
at $1,500 per year. You’ll reach the cap if your home office is 300
square feet.
Profit Limit on Deduction
There is an important limitation on tak-
ing the home office deduction: It may
not exceed the net profit you earn from
your home office in that year. If you run
a successful business out of your home
office, this limitation isn’t a problem,
because your profits will exceed your
deductions. But if your business earns very little or loses money,
this could prevent you from deducting part or all of your home
office expenses in a given year.
If your home office deduction exceeds your profits in a particular
year, you can deduct the excess in the following year and in each
successive year until you deduct the entire amount. There is no
limit on how far into the future you can deduct these expenses:
You can claim them even if you are no longer living in the home
where they were incurred. So, whether or not your business
is making money, you should keep track of your home office
expenses and claim the deduction on your tax return.
IRS Reporting Requirements
If you qualify for the home office deduction and are a sole

proprietor or owner of an LLC, you must file IRS Form 8829,
Expenses for Business Use of Your Home, along with your per-
sonal tax return. The form alerts the IRS that you’re taking the
deduction and shows how you calculated it. You should file
this form even if you’re not allowed to deduct your home office
expenses (because your business had little or no profits). By fil-
ing, you can apply the deduction to a future year in which you
earn a profit.
If you use the optional simplified method to calculate your
deduction, you need not file Form 8829. This is one of the major
advantages of the simplified method. Filing Form 8829 calls your
home office deduction to the attention of the IRS.

Chapter 12:
Inventory Deductions
When You Make or
Sell Stuff
“Always do your best.
What you plant now,
you will harvest later.”
—Og Mandino

Does your business involve buying and selling physical items?
Or, do you make things you sell? If so, you need to know about
the special tax rules that apply to inventory. If, like most self-em-
ployed people, you make a living by selling your personal ser-
vices, you don’t need to read this chapter.
What Is Inventory?
Inventory (also called merchandise) is
the goods and products that a busi-
ness owns to sell to customers in the
ordinary course of business. It includes
almost anything a business offers for
sale, other than real estate. It makes no
difference whether you manufacture the
goods yourself or buy finished goods
from others and resell them to custom-
ers. Inventory includes not only finished
merchandise, but also unfinished work
in progress, and the raw materials and
supplies that will become part of the fin-
ished merchandise.
Only things you hold title to—that is, things you own—constitute
inventory. Inventory includes items you haven’t yet received or
paid for—as long as you own them. For example, an item you buy
Chapter Twelve:
Inventory Deductions When You
Make or Sell Items

Tax Planning for Self-Employed Business Owners

Tax Planning for Self-Employed Business Owners

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