Car expenses and hot bags are not tax deductions for independent contractors in the delivery space. They are business expenses.
There's an essential distinction between the two. Knowing that distinction helps you understand the difference between employee taxes and filing as a business owner.
In this article, we'll talk about the similarities and differences between tax deductions and expenses. We'll see how expenses work for small business taxes and how you can identify the things you can write off.
- Business expenses vs Tax Deductions
- What the IRS says about when you can claim an expense
- Why you should track business expenses as a delivery driver
- What kind of expenses should you track?
- How expenses go on your tax form
About this article
This is part of a series on Delivery Driver taxes. Rather than cover it all in a single article, we decided to go in-depth on different tax-related aspects with each article. We'll link to other articles in the series, and you can see a complete list at the end of this post.
This is not tax advice. Do not take it as such. The purpose is education and information to help you understand how taxes work. You should seek out a tax professional who can guide your particular tax situation.
EntreCourier is a website that focuses on the business side of gig economy delivery, so much of the discussion will be related to delivery companies. However, many of the principles apply to other forms of self-employment.
Finally, we focus on independent contractor taxes in the United States. Local and state taxes and tax laws in other nations have their own regulations. Speak with your tax pro if you need assistance with these variations.
Business Expenses vs Tax Deductions
Tax deductions and business expenses are not the same things. It's an important distinction because they are treated differently from a tax perspective.
They are similar in that they both reduce your taxable income. However, the difference is in how and when that happens.
Tax deductions are part of your personal income tax process. You can choose between itemizing your tax deductions or claiming the standard tax deduction. All of this happens after you've determined your income while filing taxes.
However, your delivery work is treated from a tax perspective as a business. The money you receive from gig economy companies like Grubhub, Amazon Flex, Shipt, and others is not your income. Your profit is.
Here's where the difference comes into play. The process involves adding up your business income and subtracting business expenses to determine profit. You add that profit to other income on your 1040 tax form.
All of this happens during the income part of your tax return, which is different from tax deductions. This is important for two reasons:
- You can write off business expenses regardless of whether you itemize your personal tax deductions
- Many business expenses can not be claimed as a tax deduction.
What the IRS says about what you can claim as an expense
Does this mean you can just claim something is a business expense and write it off? No. The IRS is pretty clear that you cannot do that. Here's how they define whether an expense is legitimate for your business:
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessaryInternal Revenue Service Publication 535
The IRS says it must be “necessary and ordinary” to qualify as a business expense. In other words, there needs to be a business purpose, and it should be something you would reasonably expect to need for your type of business.
They clarify that it doesn't have to be indispensable. Just because you could get by without it does not rule it out. If the item helps you run your business better or more profitably, you may be able to call it necessary.
If you buy an item for personal use, you can not claim it as a business expense regardless of whether you could call it “ordinary and necessary.”
Some items may have mixed use. An example is a cell phone. Most delivery gigs dispatch offers via a website or mobile app. You can't get by without a smartphone. However, you may use it for personal reasons quite a bit. You would determine what percentage of your use is for business purposes and claim that percentage of the cost of the phone and services.
Why you MUST keep a record of your expenses
Uncle Sam will let you claim business expenses. However, you must be able to back it up.
This is true when you claim miles. It's also true when you claim other expenses like part of your mobile phone, hot bags, or other reasonable and necessary expenses.
It's kind of like the IRS is saying, “receipts or it never happened.”
Every dollar of expense that you save reduces your taxable income.
Every dollar of expenses that you track and claim reduces your tax bill. In his book “Income Tax Guide for Ride Share and Contract Delivery Drivers” John White calls it a rule of seven: Every seven dollars of expenses written off reduce self-employment taxes by one dollar.
That's before we even get started with income tax.
Your best practice is to keep records and track everything as it happens. The longer you wait, the harder it will be to go back and figure out what you spent. It also makes it easier to forget to claim the expenses at all.
But here's my main rule about tracking expenses: If you think you might be able to claim it, track it. You can always ask your tax pro later.
Use a tracking app and software. Keep your expenses by hand. Create a spreadsheet and track your costs that way. Find whatever method works for you.
What kind of expenses should you track?
We won't dive into all the different things you can write off. Other articles in this series can help you out.
The most significant expense item by far for most delivery contractors is vehicle cost. Driving is not cheap, as evidenced by the IRS letting drivers write off 62.5 cents per mile as the standard mileage allowance (second half of 2022).
For that reason, you must track every mile you drive. For a person in the 10% tax bracket, every tracked mile reduces one's tax bill by about 15 cents. While 15 cents doesn't seem like much, multiplying that by thousands of miles gets pretty significant.
The beauty of the gig economy is that there's usually not much overhead. We don't need a warehouse or office. Most of our operations are on our phones. For that reason, non-car expenses aren't typically prominent, but you should still track whatever you do spend.
We go into more detail here about what miles you can claim and how to track them. We also discuss car expenses you can claim in addition to the standard mileage allowance.
How do your expenses go on your tax return?
I mentioned earlier that the process for claiming business expenses comes from adding income and deducting expenses. This happens by filling out the form “Schedule C: Profit and Loss from Business.”
The top section of Schedule C is where you enter the income your business made. This is any money you receive from delivery companies and customer tips.
Below that is the expense section. There are several different categories listed. Enter the total amount spent in the previous year for each type, then add those to determine the total expenses.
Subtract expenses from income to get net profit. That net profit is what you add to other income on your 1040 form. It's also used to determine your self-employment tax, your version of Social Security and Medicare taxes.
The main takeaway from all of this is that you are running a business. Think of the money you get from Uber, Instacart, Bitesquad, Roadie, DeliverThat, Doordash, Grubhub, and others as your business's money. Think of the money you spend operating your business as your business's expenses.
It doesn't matter if you itemize or take the standard deduction. These are not tax deductions. You write off your business expenses on Schedule C in the income portion of your tax return.
When you understand this and claim your business expenses, you can significantly reduce your income and self-employment tax bills.
More articles in the Delivery Driver's Tax Series
Tax Guide: Understanding Your Income
The following three articles help you understand what your real income is as an independent contractor.
Tax Guide: Understanding Your Expenses
The following eight articles help you understand the expenses you can claim on your Schedule C. Most of these are about your car, your biggest expense.
Filling Out Your Tax Forms
Once you understand your income and expenses, what do you do with them? Where does all this information go when you start filling out your taxes?