Don’t forget to document your business deductions!
By: Enoch Ko
Tags: Self Employed, Freelancing, Freelancers, Taxes, Freelance

Being a business owner is great! You have the ability to write off your business expenses to maximize your tax deductions and as of result, you can dramatically reduce the tax liability.

It’s true that any expenses can be a business deduction, you need to meet & document the following four requirements in order to be qualified to be a write-off:

Business purpose — every business expense must have a business purpose (e.g., … to make a sale, to discuss a project with a contractor, etc). Ordinary — is it common & reasonable in your business industry? For example, if you are a software developer, it might not be reasonable to spend $100 on a bottle of wine for your client, but maybe it is reasonable as a real estate agent. Necessary — will this help towards the business? Every expense must increase profits, prevent losses, decrease risks, etc. Proof — depending on the type of expense, you would need to have some sort of proof to show that your expense was real. This includes receipts, bank statements, canceled checks, invoice, etc. We will expand more on this below for different types of deductions.

Without documenting the four requirements above, you risk of losing deductions and owing taxes on them even if they were legitimate business expenses. We will go in more depth on how to properly do this.

At Soraban, our team sees four types of deductions that people often don’t have proper documentation and these are:

Meals & Drinks Travel Vehicle Home office

Meals & Drinks

The meals & drinks expenses can be written off as long as it’s a business-related. As mentioned, we need to go through & document the answers to the requirements mentioned above to count an expense as a business expense:

Business purpose of the meal/drink. What was discussed? Who was at the meeting?

Explanation of why the meal is ordinary.

Explanation of why the meal is necessary.

The name, location, date, amount of the expense. Usually, bank statements have this information (if you can reproduce these details, then you don’t need to save the receipt).

Travel

Travel expenses can be written off as long it’s a business-related, but it has to be primarily for business. This means you can’t plan a trip to Hawaii and work there for a little bit to write-off the whole trip. In addition, if you want to write-off the whole trip/portion of the travel, you need at least a single day of the working day there (you need to work at least four hours on that day to count it as a working day). Unsurprisingly, you need to answer the following questions:

Business purpose of the travel.

Explanation of why the travel is ordinary.

Explanation of why the travel is necessary.

Proof: Similar to meals & drinks. It’s important to keep receipts/bank statements for each travel expense — a plane ticket, lodging, meals & drinks while traveling, Uber/Lyft rides, car rentals, etc. Again, as long as it’s possible to retrieve these details through bank statements, you don’t need to keep the receipts.

Vehicle

Vehicle-related expenses can be written off too, and there are two different ways to do so. Simple Method and Actual Method. We will write another article to address which one to use but for now, just know that you can deduct the portion of your vehicle expenses. Likewise, these expenses have to answer:

Business purpose of the vehicle.

Explanation of why the vehicle is ordinary.

Explanation of why the vehicle is necessary.

Proof: First, a mileage log to track business miles and personal miles. There are many apps out there that help with this. Second, the calculation used to determine the amount of the vehicle deduction, and list of expenses if you are using the Actual Method.

The last part might be a bit confusing but you need to be able to show the IRS how you arrived at the vehicle deduction amount in case of an audit.

Home Office

Home office expenses can be written off, and unfortunately, not many accountants let you do this. The reason for that is the home office used to be a red flag in the eyes of the IRS, but it became a common expense to be seen as such in recent years. Similar to vehicle deduction, there are multiple ways to write this off: Simple method & Actual method (by the number of rooms or by square feet).

You need to document the following:

Business purpose of the home office.

Explanation of why the home office is ordinary.

Explanation of why the home office is necessary.

Proof: First, the measurements used to calculate your home office percentage. Taking a photo of your home office also strengthens your proof. Second, the calculation used to determine the amount of the home office deduction. Third, receipts/bank statements for home office-related expenses such as rent, mortgage interest, property taxes, home insurance, etc.

In the later articles, we will go more in-depth into how to go about calculating vehicle deduction & home deduction and which method to go with. In the meanwhile, you need to keep track of these details to ensure that you get the tax deductions without any issues down the years. It is your responsibility and your accountants do not have the responsibility to verify if you have the proper documentation for each business expense.

We understand that keeping track of documentation for every business expense can be painful. This is why we built an automated tool for you at Soraban for you to easily reply to texts (our software will ask for specific documentation) whenever you have an expense in your business bank account.

Don’t hesitate to reach out to me at enoch@soraban.com if you have any questions!