What Are Some Common Tax Deductions for the Self-Employed?

The following is an interview with attorney Stephen Fishman, who’s the author of several on books on tax deductions including Deduct It, Home Business Tax Deductions, Every Landlord’s Tax Deduction Guide, and Tax Deductions for Professionals.

NOLO: Steve, what’s one tax deduction that a lot of people overlook?

STEPHEN FISHMAN: One deduction many people don’t take, even if they’re entitled to it, is the home office deduction. Many people are afraid it will result in IRS audit, or they don’t understand that they are entitled to it, and it is one of the best deductions for self-employed people if you use a home office exclusively for your business, you would be entitled to it and it’s especially a good deduction if you’re a renter because it will enable you to deduct a portion of your rent, an expense that is ordinarily not deductible.

NOLO: If you’re making the home office deduction, which do you recommend using the square footage method or the room method?

STEPHEN FISHMAN: I recommend trying both and using the one that gives you the greatest deduction. Generally, the room method will give you a larger deduction but it won’t always. It depends on how many rooms you have in your house obviously. If you have one room, you’ll be better off with the square footage. It depends on the size of the room and the number of square footage in your house. I would try both and use the one that gets the largest deduction.

NOLO: You say in your books that you can’t deduct commuting to your job, but that you can deduct traveling from your home office to a client. Why is that so?

STEPHEN FISHMAN: Commuting from home to the office or another workplace is considered a personal expense. Commuting from one business place to another, is considered a business expense. When you have a home office your home is now a place of business. So, you’re going from one place of business to another. And that is now a business expense not a personal expense.

NOLO: Here’s a similar question for travel deductions. Which makes more sense, using the standard mileage method or the actual expense method?

STEPHEN FISHMAN: The standard mileage method would generally not totally recompense you for your actual expenses, but it’s much easier to use because there’s far less record keeping involved. That’s why most people use the standard mileage rate. If you like to get every cent you possibly can and you don’t mind keeping track of every penny you spend on your car, you can use the actual expense method, and you will probably get a somewhat larger deduction. Of course, it depends how many business miles you drive.

NOLO: The rules for deducting entertainment seem so tricky as to make it not worth the effort.

STEPHEN FISHMAN: It’s not very hard at all. You just have to keep track of how much you spend and note the business reason for the expense, and keep your receipts. If they’re more than $75, you get the deduction. For many people it’s an extremely valuable deduction if you have a lot of business entertainment, you can deduct 50 percent of your business meals which can be a very substantial deduction for some people. You have to have a business purpose, not just – you have to eat with a client or a customer and you have to discuss business either before, during or after the meal.

NOLO: Steve, let’s talk about the 179 deduction for a second. Since Congress has extended the amount that you can deduct under 179, does it ever make sense to claim depreciation?

STEPHEN FISHMAN: There are some things you can’t use Section 179 for – for example, when you convert personal property to business property, and you can’t use [Section 179] for real property either. So there are times you have to use depreciation. If you buy over $430,000 dollars in one year, your deduction is also limited under Section 179.

Also, if your income is quite low this year, you might prefer to depreciate the expense if you expect your income to go up substantially in future years. You take the depreciation deduction on those future years when your income is higher and you pay a higher tax rate.

NOLO: What’s a tax credit and how can you find out if your business is entitled to one?

STEPHEN FISHMAN: A tax credit is an amount you’re allowed to deduct from your income tax. For example, if you get a $1,000 tax credit, you can deduct $1,000 from your income tax which makes it much better than a tax deduction which only reduces your taxable income. An example of a tax credit is when people refurbish their property to make it accessible for the disabled. You can have up to $5,000 tax credit every year.

NOLO: What kind of deductions can you make if your business is the victim of some natural catastrophe such as an earthquake, flood, or a hurricane?

STEPHEN FISHMAN: You may deduct the uninsured loss from your tax as a loss, a business loss.

NOLO: What if the insurance hasn’t paid? How do you know what you can deduct?

STEPHEN FISHMAN: You have to estimate how much you’re likely to recover from your insurer and just deduct the amount that you don’t expect to recover.

NOLO: What kinds of deductions can a small businessperson make for retirement plans?

STEPHEN FISHMAN: Well, there are a vast array of deductions when you’re self-employed. You have, of course, the traditional IRA which anyone can have. You have special IRAs for self-employed people called a SUP IRA.

NOLO: When you say self-employed, do you mean you have your own business?

STEPHEN FISHMAN: That’s right. You have your own business.

NOLO: Since such a small percentage of people are audited, does a taxpayer really need to be that concerned about dotting their ‘i’s’ crossing their ‘t’s’ when it comes to deductions?

STEPHEN FISHMAN: Well, it’s really true that only a small percentage are audited; only about around two percent of self-employed people are audited. So the odds are that you will not be audited. However, if you have a lot of odd-looking things on your tax return that will definitely increase the odds you will be audited. And there’s always the chance you’ll be audited. About 200,000 self-employed people were audited last year. And there’s always a chance you could be one of them. Depends if you want to play what they call ‘the audit lottery.’ You can do that and you may win. You may not. It’s up to you.