Without a doubt, the most common tax question I’m asked is “What can I deduct?” So I compiled a list of my favorite tax deductions for small business owners and the self-employed. Here’s the first five. Come back next week and I’ll give you five more.
Here we go:
1. Incorporate your sole proprietorship and be taxed as an S Corporation.
This is by far the best tax deduction strategy I know for many small business owners. It’s not for everyone, for sure. So before taking the S corporation plunge, you must do an informed analysis of the pros and cons, along with some serious number-crunching to see if the tax saving benefits outweigh the additional costs. But if this shoe fits, put it on and wear it. The tax savings can be significant.
2. Pay yourself reasonable compensation.
If you’ve already done #1, then make sure you are compensating yourself properly as an employee of your S Corporation. If you pay yourself too little, you’ll get in trouble with the IRS. And if you pay yourself too much, you’ll end up with a higher tax bill than necessary and miss out on one of the best legal tax reduction strategies on the planet.
3. Make annual contributions to your IRA or retirement plan.
To maximize tax savings now, you should contribute to a traditional IRA rather than a Roth IRA. If you are looking to maximize tax savings later (when you retire), the Roth IRA is the way to go. And if you want to contribute more than the maximum allowed by an IRA ($5,000 for spring chickens; $6,000 for older folk age 50 and up), set up a retirement plan for small business owners and the self-employed, such as a SIMPLE Plan.
Don’t have any money to contribute to an IRA or retirement plan? Then you are probably living above your means and need to learn how to spend less money, be content with less stuff, and live for tomorrow instead of today.
4. Log your miles.
This is one of the most overlooked tax deductions. Every time you drive your car for business purposes, record the date, business purpose of the trip, and the number of miles driven. How easy is that? And by “every time”, I mean just that. Whether it’s a drive to the office supply store or an out-of-town seminar, at the end of the year you get to add up those miles and get a sweet deduction. Don’t like the idea of keeping a mileage log? Then you’re a lazy fool who will continue to overpay your taxes. (You can take all this constructive criticism, can’t you?)
5. Take the home office deduction.
If you’ve got an area in your home that is used regularly and exclusively for your small business, this is a no-brainer. And yes, it does take some number crunching. And yes, the amount of your annual tax savings may be in the hundreds instead of the thousands. But what is so cool about this deduction is that you are converting non-deductible personal expenses into a deductible business expense. How cool is that?