Can You Write Off Business Expenses as a Sole Proprietor?

Running a business as a sole proprietor comes with financial responsibilities, including managing expenses. A key advantage is the ability to deduct certain costs from taxable income, lowering your tax bill. However, not all expenses qualify, and understanding what can be written off is essential to avoid mistakes that could trigger an audit or penalties.

Tax rules for sole proprietors outline specific guidelines on deductible expenses, record-keeping, and reporting requirements. Properly categorizing and documenting these deductions ensures compliance with IRS regulations while maximizing tax benefits.

Criteria for Business Deductions

To be deductible, an expense must be both “ordinary” and “necessary” under the Internal Revenue Code. An ordinary expense is common in your industry, while a necessary expense is helpful and appropriate for running your business. For example, a graphic designer can deduct specialized design software, but a personal trainer cannot.

Expenses must also be directly related to business operations. If a cost is partially for business and partially personal, only the business portion can be deducted. For example, if you use your personal vehicle for work and personal errands, you can only deduct the percentage of miles driven for business. The IRS allows two methods for this: the standard mileage rate, which is 67 cents per mile in 2024, or actual expenses, which include gas, maintenance, and depreciation.

The timing of deductions depends on your accounting method. Under the cash method, expenses are deducted in the year they are paid. Under the accrual method, they are deducted when incurred, even if payment is made later. This distinction matters for businesses with outstanding invoices or prepaid expenses.

Types of Deductible Expenses

Sole proprietors can deduct a range of costs to reduce taxable income. Home office expenses apply if a portion of your residence is used exclusively for business. The IRS offers a simplified option allowing a deduction of $5 per square foot, up to 300 square feet, or the regular method, which involves calculating actual expenses like rent, utilities, and property taxes based on the percentage of space used for business.

Marketing and advertising costs are deductible if they directly promote the business. This includes website development, social media ads, business cards, and promotional materials. Sponsorships or event participation fees may also qualify if they generate business income.

Payments to employees and contractors can be deducted, including wages, salaries, and benefits. If you hire independent contractors, payments must be reported on Form 1099-NEC if they exceed $600 in a tax year. Contributions to retirement plans, such as a SEP IRA or Solo 401(k), are deductible, with contribution limits set annually by the IRS.

Professional services, such as legal and accounting fees, qualify if they are directly related to business operations. This includes tax preparation, business formation, and contract review. Memberships in professional organizations and industry-related subscriptions may also be deducted if they provide value to the business.

Maintaining Supporting Records

Accurate record-keeping ensures deductions withstand IRS scrutiny. Every business-related financial transaction should have documentation, including receipts, invoices, bank statements, and contracts. Digital records are acceptable, and accounting software like QuickBooks or Wave can help categorize expenses for tax filing. Keeping separate business and personal bank accounts prevents commingling of funds, which can raise red flags during an audit.

Some expenses require additional substantiation. For business meals and travel, the IRS recommends maintaining a log with the date, amount, location, business purpose, and attendees. For vehicle-related deductions, a mileage log tracking business trips with odometer readings is necessary.

Supporting records should be retained for at least three years, the standard IRS audit window. However, if substantial underreporting of income (over 25%) occurs, the IRS can audit up to six years. In cases of fraud, there is no statute of limitations. Electronic backups stored on cloud platforms or external drives protect against accidental loss or damage.

Filing Requirements

Sole proprietors report business income and expenses on Schedule C (Form 1040), which must be filed with their individual tax return. The net profit or loss from Schedule C flows into Form 1040, impacting overall taxable income. If net earnings exceed $400, self-employment tax—covering Social Security and Medicare—must also be calculated using Schedule SE. The self-employment tax rate is 15.3% in 2024, but 50% of this amount is deductible when determining adjusted gross income.

Estimated quarterly tax payments are required if total tax liability is expected to exceed $1,000 for the year. These payments cover both income and self-employment taxes and are due on April 15, June 15, September 15, and January 15 of the following year. Failing to pay sufficient estimated taxes can result in penalties, calculated based on the IRS underpayment rate, which fluctuates quarterly.

What Happens If You Show a Net Loss

A net loss occurs when deductible business expenses exceed revenue, reducing taxable income. While this can lower tax liability, repeated losses may attract IRS scrutiny if the business appears to lack a profit motive. The IRS applies the “hobby loss” rule, which limits deductions if an activity is not engaged in for profit. To avoid reclassification as a hobby, business owners should maintain thorough records, demonstrate efforts to improve profitability, and show a history of occasional profits.

Losses can also provide tax benefits through the net operating loss (NOL) provision. While the Tax Cuts and Jobs Act eliminated NOL carrybacks for most taxpayers, losses can be carried forward indefinitely, subject to an 80% taxable income limitation. This means a sole proprietor with a $20,000 loss in one year can offset up to 80% of taxable income in future profitable years. However, NOLs cannot be used to reduce self-employment tax, making it important to plan deductions strategically.