Guide

Tax deductions for sole proprietors

If you’re a sole proprietor, claim business expenses to reduce your tax bill. Here’s how these tax deductions work.

A small business owner filing tax reports at their desk

Why tax deductions matter

A sole proprietor is someone who owns an unincorporated business by themselves. As a sole proprietor, your business is not a separate legal entity from you, which has implications for the tax you pay. However, you might be entitled to tax deductions that reduce the amount of tax you owe. You’re required to accurately determine and deduct your business expenses, so it’s important to know what counts as a tax deduction.

What is a tax deduction?

A tax deduction is a business expense you claim to reduce the amount of tax you pay. These business expenses are deducted from your gross income to reduce your taxable income, and the amount of tax you owe. Most business expenses qualify as a tax deduction.

How to claim tax deductions

Unless you set up your business as a corporation or partnership, you’re taxed as a sole proprietor. This applies to independent contractors, too.

As a sole proprietor, you claim most business deductions on IRS Schedule C. This form is mainly used to record your deductions, so make sure to keep records of your business expenses, including proof of purchase like invoices or receipts.

What business expenses can I deduct from my taxes?

Most business expenses are tax deductible. This includes money spent on supplies and services that are critical to your business. Even if your business is just you and your laptop, you might still have deductible expenses.

That said, some expenses – like entertainment – are not deductible.

Common deductible expenses

  • workplace costs like rent or mortgage interest, utilities, maintenance and insurance
  • internet and phone
  • advertising and website
  • office supplies
  • business-related vehicle costs
  • business travel
  • professional memberships and publications
  • interest on business loans
  • business insurance

Workplace (including home offices)

You can claim workplace expenses like rent or mortgage interest (if you own your place of work), utilities, maintenance and insurance.

If you operate out of a dedicated workplace, the entire cost is usually tax deductible but it’s not so straightforward if you work from home. In that case, you’ll need to calculate how much of your home is used exclusively for your business. You can calculate this area as a percentage of floor space and then claim this percentage of costs as a deduction. Or you can use the simplified option and claim a set rate per square foot, up to a total of $1,500 for the year. The IRS has specific rules for home office deductions, so consult your tax advisor to check you’re using the right option.

Internet and phone

You can generally claim the cost of work-related internet and phone use. Again, this can be more complicated if you run a home-based business. You need a reasonable way to estimate what portion of your home data is used by the business, and the same goes for mobile phone calls. Home-based businesses can’t claim landline costs unless they have a second, dedicated business landline.

Advertising and website

Advertising is a business expense. This is easy to forget when you’re experimenting with digital marketing. It’s common to trial small social media or paid search campaigns to see what works. Make sure you keep good records of all these expenses for tax time. Your website is a business expense, too. Besides production costs, you can claim domain name and web hosting fees, which are recurring annual costs.

Office supplies

Stationery, printing consumables, postage and most other day-to-day office supplies are tax deductible. You can also claim for office equipment like printers, scanners, furniture and computers.

Vehicle expenses

It’s common to use your personal vehicle for business activities, and you can deduct these expenses from your business income. Record the date, distance and purpose of each business journey to claim the IRS’s flat rate for each mile traveled. Or, you can calculate your total vehicle expenses for the year and claim the amount that applied to business use. To use this method, you’ll need to track all of your vehicle expenses (including depreciation) in detail, as well as tracking your mileage.

Business travel

You can deduct business travel expenses such as fares, accommodation, meals and transportation at your destination (including cabs, car hire or metro transit services). This travel can be to meet clients, find new business or to get training. Most business travel expenses can be fully deducted, but the amount you can deduct for meals might vary.

Meals

From 2023 onwards, you can only claim half of the cost of meals purchased while on the road for business, or when meeting with a client. For 2021 and 2022, you can deduct the full cost of meals. Make sure you keep receipts and record how those meals are related to your business activities.

Professional memberships and publications

You can generally claim your membership fees for professional organizations, such as trade associations or chambers of commerce. This doesn’t extend to social or country clubs, as their primary purpose is to provide hospitality or entertainment.

You can also deduct the cost of magazines, journals and books that are related to your field of business.

Interest on business loans

You can deduct the interest paid on your business loans. You can’t claim your total loan payments, as this includes the principal. Your loan statements should show how much interest you pay each year. This deduction also applies to the interest you pay for business-related expenses that were purchased using personal and credit card loans.

Business insurance

You can deduct the cost of premiums on policies taken out to protect the business. This can include insurance for assets and income, or insurance against business liabilities.

Non-deductible expenses

Personal expenses can’t be deducted from your business income, even if you purchase them through your business. When an expense has both a business and personal component, you can claim the business portion, but you’ll need to show how you calculated this amount. The IRS provides guidance on how to determine these calculations.

You’re not able to deduct fines or penalties payable to the government, even if they were assessed against your business.

If you purchase an item over $2,500, you may not be able deduct the total cost in the same year you purchased it. Please check with your tax advisor for more information.

Extra Social Security and Medicare requirements

As a sole proprietor – this includes independent contractors and anyone who’s self-employed – you face extra taxes. That’s because payment of Social Security and Medicare taxes is shared between an employee and employer. Now that you’re both, you pay the total. As an employee, you may have paid 7.65% in Social Security and Medicare taxes, with your employer paying another 7.65%. Now that you work for yourself, you pay the total of 15.3%.

Side-hustle jobs on tax returns

If you’re self-employed and haven’t set yourself up as a partnership or corporation, you’re taxed as a sole proprietorship. Even if you don’t consider your freelancing side hustle as a business, the IRS does. Make sure you count all of your business expenses, keep records of the transactions and claim them on IRS Schedule C.

How to keep tax records

It’s helpful to run all of your transactions through a dedicated business bank account so your bank statement provides a good record of amounts spent and received by your business.

You also need to hold onto receipts and invoices you’ve received. Record all of them, even if you’re unsure whether the expense can be deducted. You can always check these expenses with a tax professional later.

Many businesses take pictures of their receipts and store them online, rather than storing them physically. It helps to keep notes for each picture, detailing what each receipt or invoice was for to help jog your memory.

Online accounting software like Xero has a feature that lets you upload pictures of receipts and extract key details to automatically record your expenses. You can also upload other documents and files to accurately capture your business data.

Disclaimer

Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.

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