Does Having a Small Business Help with Taxes?

Does having a small business help with taxes? A small business definitely allows you the opportunity to take expense deductions that you otherwise may not get as an employee. Employees may incur assets to do their job but they can’t take a deduction on them because of their classification.

The federal government doesn’t allow you as an employee to deduct expenses that aren’t reimbursed from your employer. Now, if your employer is reimbursing you for your out of pocket expenses, that’s great. Then you’re not out those dollars. But if you have to put out money that you can’t get a deduction for, and you’re not getting reimbursed, then you’re kind of in a worse position as an employee than if you were the employer. Now, there’s other benefits that the employer can give you. But strictly speaking, on the expense side, you’re behind a business owner.

How do Taxes Work with a Small Business?

One of the biggest benefits of being an employee is that your employer will provide half of your Medicare and Social Security taxes. Those can be pretty steep as far as a percentage goes. When you are considered self employed, or have a business of your own, many times you would be liable for the full amount of those taxes on your own.

Being in business for yourself, it’s not just the expenses that you can benefit from. There are other deductions that you could potentially have. Especially when you’re looking at retirement plans. When you’re an employee of somebody you’re stuck with whatever retirement plan that company has, if they even have one. When you are self-employed, there’s a number of different options you have for setting up a retirement plan. There’s lots of different contribution levels. So you can really sock away a lot of money in retirement, potentially, having your own business. That can help you in taxes and to also help your financial security in the future.

Tax Benefits of Having a Small Business

So let’s talk about some of the deductions you can take as an employee or as a self employed business owner. Many times, even as an employee, you maintain some sort of office. That could be in your home or renting an office space. Those are the types of deductions that most small businesses incur.

We like to put deductions in two different buckets: direct expenses and indirect expenses. The direct expenses are things that you have to pay directly. Such as any supplies, rent for the office or facility, business insurance, hired employees, etc. Indirect expenses are more of the things that are part business part personal. Such as a cell phone, a personal car, or a home office. These are mixed use expenses that are incurred both personally and through your business. Many people like to take aggressive positions on getting deductions for automobiles and say they don’t go anywhere other than the office. That can work to a certain extent. But we all know we use some bit of that personally.

Anytime you have a mixed use expense, you want to make sure that you’re tracking the personal versus the business. For a car that would be tracking personal vs business miles. For a home office you would figure out the percent of the home that you’re using for business. There’s some special rules that the IRS requires in order to be able to do that.

The Importance of Tracking Your Expenses

I have a story that is a good example. Somebody works for a company. They subscribe to certain journals for their industry to keep up on the changing landscape. In their house they have an office that they use for their business. They decide later that they’re going to become a consultant doing the same thing but not working for a particular employer anymore. They are now a subcontractor, and what used to be non deductible things now are able to be written off against that income that they’re receiving as a subcontractor.

It’s a different mindset shift when you go from being an employee where either they reimburse you or that you’re just not able to take those expenses, to an a subcontractor or running your own business, and looking for the things that really are associated with the business that maybe before you were not able to take as deductions.

You have to be able to track all of these things, and you have to be able to organize all of that stuff. And that’s where potentially an accounting software may need to be implemented or some sort of spreadsheet. You may also need separate bank accounts and separate credit cards so that you’re able to track that stuff a lot easier. We always recommend that to anybody who has a business – to keep everything in a separate account.

Even a sole proprietor could benefit from that, because, although it’s not required, it is so much easier to manage those expenses and understand what’s being spent on the business. It just gives you a leg up in the organization of it.