Tax Deductions for the Home-Based Sole Proprietor

Tax Forms

Tax FormsTax time is here again! What do you need to know about tax deductions when doing business as a home-based sole proprietor? You may be thinking, “I’ll hire an accountant or go to one of those tax preparation kiosks in the mall,” or “I’ll just use one of those computerized tax software programs.”

Whatever your decision, you are ultimately responsible for knowing what you can and cannot deduct as business expenses. Why? YOU are accountable to the IRS for your deductions, not the tax preparer.

But the most compelling reason: Getting the greatest benefit from your deductions. If you pay someone to do your taxes you still need to know what you can deduct so that you can gather all relevant paperwork!

Let’s start with the basics:

Advertising costs

  • Basic Office Supplies (paper clips, pens, pencils, paper, toner/ink cartridges for printer, etc.)
  • Telephone
  • Bank Fees
  • Business Insurance (insurance related specifically to operation of your business)
  • Business Equipment
  • Internet Fees (if used in the course of your day-to-day business operations)
  • Books/Subscription Fees
  • Postage
  • Vehicle Expenses
  • Home Office Expenses
  • Legal and professional services
  • Taxes and licenses
  • Meals and Entertainment (* see IRS Publication 463)
  • Tax preparation

The list above is based on Schedule C of IRS form 1040. Be sure to look over Schedule C when you are setting up your books for tracking expenses. Schedule C will help you determine what you should be tracking. If something is not listed as a category you need, then you list it separately under “Other Expenses.”

This next section is an expanded discussion on selected items from the above list. These are often unknown or overlooked deductions.

Business Equipment

The section 179 deduction lets you deduct the entire purchase price of business equipment the year you put it into service up to a limit. The term listed property according to the IRS applies to items that are generally used for entertainment or recreation, but may be used for business as well, such as computers, cell phones, cars and video cameras.

Of course this assumes that the listed property is used 100% for business. If it is used for business more than 50% of the time, then you may deduct the corresponding price, up to the limit.

“Yikes!! But my computer is used by my family, what do I do now?” You will need to keep a log of its usage. Place a pad of paper and a pen next to the computer and ask all who use it to write down the time when they start/stop using the computer. You do likewise for your business time, this way you will be able to prove that the computer was used 50% or more for business use. You must also place the computer in a room other than your home office or the non-business use will violate your home office’s requirements of exclusive business use.

This applies to all listed property. Keep a log showing both business and non-business use.

The total limit on Section 179 deductions increased through 2003, when it topped off at $25,000.

Company phone

Do you have phone lines separate from your home phone? You should! It makes it easier to deduct phone expenses, makes the bookkeeping simpler too! If you decide that you only want one phone line, you can deduct all business related long distance calls and any special services such as call waiting, but you can not deduct the basic cost of the phone service.

Health Insurance

Did you know that health insurance deductions keep increasing? You can deduct a percentage of your health insurance payments for yourself, your spouse and your dependents.This applies only to health insurance that you purchased as an individual. If you are still paying an employer for your health insurance (yours or your spouse’s) you are not eligible for this deduction.

Tax Preparation

Since you are a sole proprietor the preparation of your taxes can be more complicated. If you choose to have someone prepare your taxes, then be sure to ask them for an itemized bill. The cost of preparing all business related paperwork is deductible.

Home Office deductions

This is the one deduction that is really tricky! The IRS says that in order todeduct any expenses related to having a home office the area MUST BE USED EXCLUSIVELY AND REGULARLY FOR MANAGING YOUR BUSINESS! The good news is that they have expanded this definition to include something as simple as a counter top or a desk, IF you use it exclusively and regularly for business.

This now includes those previously excluded from claiming a home office deduction – such as consultants, salespeople, and even doctors who use a home office to manage a practice – they can now claim that space! Once you have determined that is it exclusively and regularly used for managing your business, what can you deduct and how much?

You can deduct a percentage of the total cost for rent, utilities, insurance, repairs and trash collection from your business income. If you own your home you can even claim a portion of the depreciation in value.

How do you figure what percentage to use? You calculate the percentage of your home office to the total size of your home/apartment. You can be exact by measuring square feet or you can count rooms. Then use that number to figure the dollar value of each deduction. The dollar value is the total amount you have paid for allowable deductions during the year, multiplied by your home office percentage. The resulting sum will give you your total deduction.

Tax time may not be enjoyable, but with a little knowledge you can get the most from your deductions!

For more information or details relating to filing taxes as a sole proprietor, the following web sites will help:

For an in depth discussion of all business related expenses for a sole proprietor read IRS publication 334, Business Expenses for the Sole Proprietor.

(All IRS publications referenced in this article are available for download at the IRS web site listed above.)