This guest post was written by Josh Bauerle, Founder of CPA On Fire.
Taking the Tax Deductions You Deserve as an Entrepreneur
In 2010, a California wine bar owner named Rick decided he wanted to improve the quality of his wines.
While most bar owners would look to change their vendors or simply purchase higher-end wine, Rick went in a different direction.
After giving it a lot of thought, he decided the best thing to do would be to improve the quality of his own nose in order to better identify good wines on his taste testing trips. He had never been happy with the way his nose looked and figured that he could kill two birds with one stone: improve his looks and his business at the same time with a good nose job.
Being a prudent entrepreneur, he attempted to write off the entire $9,500 cost of the surgery as a business expense.
Typically, the IRS disallows any cosmetic surgeries or changes to your appearance as a tax write-off. They generally take the stance that even if these surgeries end up improving your business in some way, they are mostly done for personal reasons. But in a surprising move, the IRS decided to allow this wine bar owner to deduct his nose job as a business expense.
While I wouldn’t recommend writing off your next cosmetic surgery on your tax return, this story offers a great lesson in business expenses for entrepreneurs.
Let’s keep digging to find out more…
What is a Business Expense?
One of the questions I’m asked most frequently by entrepreneurs is “what kinds of expenses can I deduct in my business?”
Unfortunately, without knowing all the information about your business and lifestyle, this is a difficult question to answer. But if I can’t give you an exact answer on what you can deduct, maybe the IRS can help us out. Let’s take a look at their definition of a business expense:
“A business expense is an ordinary and necessary expense that was paid or incurred during the taxable year in carrying on a business activity.”
Well that clears it up, right? Yeah, not so much…
The IRS is the master when it comes to being vague. But there are two key words you need to focus on in this definition: “ordinary” and “necessary”.
Any expense you can get to fall under the definition of these words can likely be deducted on your tax return.
Going by Webster’s definition of the word ordinary, you would likely think that a business expense has to be “customary, usual and normal” in order to be deducted. But for the IRS, the word ordinary simply means “not completely unusual for the industry your business is in”.
This means that what is ordinary for one business isn’t necessarily ordinary for another business. Going back to Rick’s example, the IRS decided that while a nose job is not an ordinary expense for most businesses, it is not completely unusual for someone who relies on their sense of smell in their business.
What you can take away from this is that anything you spend money on could be a tax deduction if you can find a way to relate it to your business or industry. Is your new BMW a business expense? If you run a home business that rarely requires travel, then probably not; but if you are a Real Estate Agent, then it absolutely could be.
Once again, going by the actual definition of the word necessary would lead us to believe that an expense would have to be “indispensable or required” in your business in order to claim it as a tax deduction. And once again, the IRS has a much simpler definition.
In order to meet their standards for necessary, an expense must be “appropriate and helpful in the course of your business or industry“.
As with ordinary, whether an expense is necessary or not will depend on your business and the industry it’s in.
Looking back again at Rick’s nose job, the IRS determined that paying for a more efficient nose is both appropriate and helpful for someone purchasing wines for a living.
Increase Your Tax Deductions by Expanding Your Industries
If the IRS determines allowable tax deductions based on the industry your business is in, then the best way to increase your deductions is to expand your industries. And doing so is probably easier than you think.
Let’s look at a plumber who owns his own plumbing business:
Plumbing is a pretty specific skill set, and transferring those skills to a different industry seems difficult, right? But what if he writes an eBook, Ten Common Toilet Problems and How To Fix Them Yourself? Now he is an author in addition to being a plumber, and therefore, he is entitled to the tax deductions of both industries.
After his eBook sees some success, he decides to start a podcast discussing quick plumbing tips a few times a week. Now he has entered the media industry and has opened a new set of tax deductions.
Finally, he has other plumbers coming to him asking him how he created such a diverse and successful business, so he creates online courses teaching them what he knows. He is now in the teaching industry and is entitled to many of their tax deductions as well.
So by simply finding new ways to leverage his skills, this plumber has significantly increased the tax deductions the IRS will allow him to take, not to mention the additional revenue he has created for himself.
Always Play by the Rules
None of this means that you should ever try to cheat the IRS out of tax money that rightfully belongs to them. You should always play by their rules and follow the guidelines they give. Getting caught taking a tax deduction you aren’t entitled to will end up costing you significant time and money in the end.
What it does mean is that the IRS gives entrepreneurs some leeway, and with a little bit of planning you can minimize your tax liability and maximize the amount of money you keep in your pocket.
Being an entrepreneur comes with several tax advantages. By following these guidelines and strategies, you can be sure you’re getting all the deductions you are entitled to while keeping in line with the IRS at the same time.
What questions do you have about your taxes as an entrepreneur? Let us know in the comments section below!
This post was written by Josh Bauerle. Josh is a CPA and the Founder of CPA On Fire, which specializes in providing tax and accounting services for small business owners.