Business expenses are the reasonable and necessary costs or expenses of producing self-employment income incurred by the self-employed person. Business expenses must be verified. The client has full responsibility for providing proof of any business expense.
Allowable business expenses are subtracted from countable income.
What to Allow as a Self-employment Expense
Allowable self-employment business expenses include, but are not limited to:
- carryover of previous year's losses,
- cost of stock and inventory,
- cost of operating machinery or capital equipment,
- costs of employee benefits, such as health insurance, dependent care assistance, and life insurance,
- entertainment expenses,
- federal, state, or local income tax payments,
- interest on loans for capital assets or durable goods,
- fire, theft, flood, or similar insurance, liability insurance, and contributions to industrial compensation and unemployment insurance,
- salaries for employees other than the client (business owners/partners are not employees),
- space rental,
- transportation expenses required for employment,
- taxes on the business property, such as real estate and vehicle taxes.
Income reinvested in a business, except for the purchase of real estate, is an allowable business expense. This includes the purchase of capital equipment, payment on the principal of loans, and other expenses needed to produce goods and services.
NOTE: Capital equipment is equipment needed to produce self-employment goods (e.g., a printing press, copy machines, farm machinery, tools, sewing machines, tractors, tow trucks, etc.).
Business Portions of Household Living Expenses
Portions of household living expenses may be an allowable business expense. The allowable expense is the amount of the increased cost due to the business.
Do not count any portion of household living expenses as a business expense when the self-employment activity does not increase the amount of the expenses.
When to Income-average Expenses
Use income-averaging to determine the amount of the deduction when the only expense is paid weekly or every other week.
The cost of travel necessary for work is allowable. Allow the amount the client claims in their self-employment record for transportation as an expense. The client's record is verification of the expense. If a client uses their vehicle for both personal and business purposes, allow a percentage of the cost for things like repairs, tune-ups, etc., as a business expense. Allow a percentage of the vehicle costs equal to the percentage of mileage that the vehicle was used for business purposes.
Self-Employment Rental Income
For self-employment rental income, determine the net earned income from rental by subtracting the expenses of rental from the gross income. Expenses include, but are not limited to:
- utility expenses paid by the landlord,
- insurance, and
- interest on rental property mortgage payments.
When the client and the tenant(s) occupy the same building and the expenses are not billed separately, base the expenses on the percentage of the number of rooms occupied by the tenant to the total number of rooms in the building. For example, if a tenant occupies 5 rooms and there are 12 rooms in the building, the expenses of rental are 5/12 of the total expenses.