In other parts of this tax guide, I've made this point, and it's worth repeating.
Your business expenses are NOT deductions. At least not in the same way as your mortgage interest or charitable giving that you itemize. You do not claim them as part of your itemized deductions.
And here's the great part: You can take the standard deduction on your taxes and still claim your business expenses. That is because your expenses are actually listed as part of the income part of your tax filing, not the deductions.
As part of the income reporting process, you fill out a Schedule C that lists both income and expenses for your business, and it's the difference between the two that is reported as income.
Introducing business expenses
This article is an introduction to the topic of expenses. It's not meant to cover all of the expenses you can claim. That will come in future articles.
The idea here is to understand what they are, and why they are so important to keep track of.
What are business expenses?
Remember that the IRS sees your independent contractor work as a business, not a normal job. This is why Schedule C is called “Profit and Loss for Businesses.”
The whole point of a business is not how much money comes in. It's all about what's left over after expenses.
What we are doing here then is keeping track of what those business expenses are. If we spent money as part of operating our business, we SHOULD keep track of that so that we don't pay more in taxes than we should.
The most important rule here: It must be reasonable and necessary.
This is the primary rule the IRS uses. An expense must be reasonable and necessary.
It should make sense that you spend the money to operate your business. Your expense should be needed to fulfill a business purpose.
Driving your car for deliveries makes sense. In a lot of situations it's actually quite necessary if you want that food to the customer quickly.
If you need it to run your business, if it makes sense and helps you achieve a business purpose, it will probably qualify as a business expense.
Why it's important to track your expenses.
Uncle Sam wants your money. If you earned it, he wants a part of it.
But he's only entitled to the PROFIT part of your money. If you are not tracking your expenses, you are letting him have more money than he deserves.
In his book “Income Tax Guide for Ride Share and Contract Delivery Drivers“* John White talks about his “Rule of Seven.” (Full disclosure on Amazon links: as an Amazon Associate I earn from qualifying purchases)
You will pay a dollar of self employment tax for every dollar you earn.
You will SAVE a dollar off your self employment tax for every seven dollars you record.
In other words, if you failed to record $7,000 worth of expenses, you will owe $1,000 more in self employment tax.
And oh, by the way, probably $700 or more in additional income tax.
I don't know about you, but I have better things to do with that $1,700 than to send it in to Uncle Sam.
But here's the thing: You can't claim it if you didn't track it. You cannot claim it if you do not have proof that you spent it. You have to keep good records.
What expenses can you claim?
We're going to get into a lot more detail if future articles.
Your major expense, if you drive, is your car. In fact, we're going to have five different articles about your car expenses.
That might seem like overkill. However, as important as that car expense is and as many questions as people have about claiming their car or mileage, etc., I think it's worth taking the time.
There's a lot of rules around claiming your car mileage or expenses. You can do a lot of book keeping tracking every single penny you spend on gas, oil changes, depreciation, etc.
The IRS lets you simplify that by claiming a standard mileage rate. You can choose either the actual expense or the per mile rate (57.5¢ per mile in 2020)
Your smart phone is reasonable and necessary for operating your business. That means your cell and data plan are as well.
We'll get into more depth soon enough on the different kinds of things that qualify as expenses. If it's reasonable and necessary for operating your business, you probably can claim it.
Do you have to write down ALL of your expenses on your tax form?
You're not required to list your individual expenses on your tax forms. You will fill out a form called Schedule C. On that form there's a list of business expense categories.
What you will do is enter the total you spent for each category. There are some items that don't have a category, and schedule C allows you to list them in a part called “other expenses.” (Creative name).
Further on, we'll get into some of the common expenses and what category they would fit under.
Can I claim anything I want?
No. No. Absolutely No.
I will warn you. Don't go crazy. There's a recurring theme in this Tax Information Series: The IRS looks for patterns.
When you fill out your schedule C, you tell the IRS what kind of business you operate. They've got data on thousands of businesses like yours. That means they've got a good idea what kind of expenses are reasonable and necessary for a delivery business.
Tracking and claiming your expenses
If you want to claim your expense, you have to track it. You have to have proof that you spent the money, and that you used it for a business purpose.
Use a tracking app and software. Keep your expenses by hand. Create a spreadsheet and track your expenses that way. Find whatever method works for you.
Don't forget to track your miles. It's an absolute must if you drive your car. Failing to do so can cost you thousands in extra taxes. I'm serous. Thousands.
We took a look at several different mileage and expense tracking apps and compared them side by side. There are several that will work for you. The one that came out on top is Hurdlr. They have a pretty powerful free version that you can start with as well as a paid option.
Here's my rule about tracking: If you have a feeling it's a legitimate expense, track it. Document it. Keep a record.
Tracking an expense is not the same as claiming it.
That's why I say track it now, ask your tax pro about it later.
If you track it and you find out you can actually claim it, you're in great shape. You've got a record of it.
If you don't document it and find out later that you could have claimed it, now you're in a spot. You might be able to go back and find documentation of the cost, but it could be tough.
It's easier to decide not to claim something that you tracked than it is to try to find documentation for something you didn't track.
Tracking it simply means you're keeping a record of it. It's when you include that expense in your Schedule C that you're actually claiming it. That's why it's not a bad thing to track it. If you're working with a good tax pro, they'll help you know when NOT to claim what you tracked.
Be reasonable on the one hand.
On the other hand, be thorough. Capture every penny of expense you are allowed to capture. Capture every mile you drive for business.
Unless of course you just enjoy sending too much money to the government.
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?