Why tracking your business expenses is so important
No one decides to make the leap into self-employment because they really look forward to bookkeeping. In fact, I’m willing to bet that when Stride members made pro and con lists to help them decide whether self-employment was the right choice, they put “bookkeeping” and “taxes” in the “cons” column.
Even though keeping track of your spending can be a pain, knowing how to maximize your tax deductions is incredibly important in making sure your business stays financially healthy! When you don’t track your expenses you’ll likely overpay in taxes—not to mention spend valuable time piecing together your tax return in April.
Here’s why tracking your business expenses can save you money.
When you prepare your tax return every year - more specifically your Form 1040 - the IRS is asking you to list how much and what kind of taxable income you earned over the past year. When you earn certain kinds of income, the IRS will have you fill out an extra form to describe that particular kind of income. Made some rental income in 2017? You probably had to file an extra form called Schedule E to describe your rental income and expenses.
When you report that you earned self-employment income, you’ll need to fill out an extra form called a Schedule C, so that you can tell the IRS:
1) How much business income you received
2) How much you spent on keeping your business running
3) How much net income (or net loss) you had for the year.
The reason the IRS asks for all of the above information is because you only have to pay taxes on your profit from your business. Your business profit is your business income, minus your business expenses.
Any “ordinary and necessary” payments that you make to keep your business running are considered business expenses. Business expenses are deductible on your Schedule C, meaning you can subtract them from your taxable income.
A good rule of thumb: If an expense was reasonable for your industry, and unavoidable in the regular course of your business, then it’s deductible as a business expense.
Business expenses explained in a real-life example
Let’s say you make self-employment income as an artist, and earned $10,000 in 2017 from selling your paintings. If you report that $10,000 on a Schedule C when you file your taxes, an average 30% tax rate will mean you’re paying about $3,000 in taxes.
However, you also spent $3,000 on paint supplies so that you could create those paintings in the first place. Here’s what that information will look like on a tax return:
When you report your painting income on your tax return, you’ll do some easy math to show that your business profit was $7,000 ($10,000 in income minus $3,000 in expenses).
Since you’re only taxed on your business profit, you’ll pay taxes on $7,000 of income instead of the full $10,000. At an average tax rate of about 30%, you’re now paying $2,100 in taxes instead of $3,000. That’s a difference of $900 in tax money, right back into your pocket!
Tracking your business expenses is a year-round effort
By tracking your business expenses throughout the year, you’re essentially chipping away at your taxable income to lower the amount that will eventually be taxed. That’s why it’s so important to track your expenses throughout the year—every time you include a business expense in your records, you’re literally putting money back into your own pocket!
Need a good way to keep track of all your expenses? Our free Stride Tax app can help you.
That said, if you’re self-employed, you’re probably incurring business expenses left and right (especially if you’re self-employed full-time). Between the receipts, invoices, bank transaction records, and cash logs that build up over time as you’re running your business, you’ll have a lot of paperwork to keep track of throughout the year. You’ll also find yourself riling through all of that paperwork when you’re filing your taxes and need to tally up your expense totals.
The best way to stay organized throughout the year and to make sure you won’t lose track of deductions is to keep all of your expense records in one place, and add new expense records on the go.
You may be wondering what kind of tools or apps you can use to help you with this cumbersome task. At Stride, we believe in helping people who work for themselves be more productive and successful. That’s why we built Stride Tax, a free mileage and expense tracker you can use to record your expenses on the go. You can keep a running tally of expenses in your Stride account, and store pictures of your documentation (like receipts, invoices, etc.) so you can get rid of as much paperwork as possible.