Information for self employed individuals
Note: this article is primarily intended for individuals who file a Schedule C. Most of these concepts are available/applicable to Partnerships (form 1065) and Corporations, but they often work a little differently. If you have questions about the destructibility of these or are items, your best course of action is to contact our office with your specific question.
There’s a lot to learn and understand about running your own business. One area that many business owners neglect is to develop an understanding of taxation works in regards to their business, often resulting in an unpleasant surprise in April. This page is intended to simplify some concepts, introduce you to some deductions that you may want to be taking on your returns, and inform you about the regulations around those deductions to be sure every position you take on your tax return is rock solid in the event of an Audit.
The Basics: Revenue, Income, and Deductions:
Revenue
Revenue is an easy topic. Revenue is all the money that you earned from customers before expenses. So, if you have a lemonade stand and collected $10 from customers, even if you spent $2 on lemonade mix, your revenue is $10.
Income
Income is what’s left over for you, the business owner, after all expenses. This is what is taxable. If your lemonade stand collected $10 from customers and you spent $2 on lemonade mix, your income is $8. So, you take your $8 home, that’s yours. Wait! In fact, there’s one more expense: taxes-which have to be calculated last because they are by definition a percentage of your income. If the tax rate is 25%, that means after you earned $8 at your lemonade stand you should have saved 25% ($2) for taxes. You may even be required to pay those taxes prior to filing your tax return in April. For more information on that, read about Estimated Payments.
Deductions (expenses)
The Federal Government taxes Income not Revenue. This is why deductions are important. If your lemonade stand collected $10 from customers and you spent $2 on lemonade mix, your deductions (expenses) are $2.
The IRS defines expenses (deductions) very broadly, stating that you are allowed to deduct “All ordinary and necessary expenses…” in our lemonade example the IRS will tax you on your $8 of income, not your $10 of revenue, because you spent the $2 to make the $8.
The deduction does not have to have been successful to be deductible. Lets say our lemonade stand paid $5 for an advertising campaign which brought in 0 customers. They still get the deduct that expense.
More advanced topics:
Self employment tax or: why are my taxes so high now that I started a business?