Can I claim my tools as a tax deduction?
Yes. The cost of all “ordinary and necessary” tools, materials, and equipment paid for by yourself or your business can be deducted from your total reportable income. You must be prepared to justify why the tool was needed and able to demonstrate that the tool was used wholly for business purposes.
What kind of records should I be keeping regarding my taxes?
You should track all income and expenses, as well as any other records needed to document other deductions you might be making. Income should include a report of all invoiced or billed payments. If you intend to separate business income from personal income, you must document all withdrawals made to your personal accounts. It is also advisable to withdraw a set amount each month and to diligently separate personal versus business spending.
Documenting expenses should be done in a spreadsheet, logbook, or another organized method. You should also save all receipts, pay stubs to workers, and bills or invoices related to business expenses. Generally, you can simply report your list of expenses, but in the event of an audit or a request for more documentation you should be prepared to justify and prove any expense made.
What is the difference between an “ordinary” and a “necessary” expense?
The IRS states that only “ordinary and necessary” business expenses may be deducted.
According to the agency’s website: “An ordinary expense is one that is common and accepted in your trade or business.”
In other words, unusual expenses or ones that seem unrelated to your business may not be deductible. For a construction contractor, a 10-foot trailer for hauling tools may be considered ordinary whereas a 25-foot yacht may not be. If you think an expense may not be considered ordinary, document its use by the business, and be sure not to derive any personal use from it to maximize the chances that it can actually be deducted.
Also per the IRS: “A necessary expense is one that is helpful and appropriate for your trade or business.”
Filers should be prepared to indicate why every deducted expense was needed by the business. Importantly, the IRS states that “An expense does not have to be indispensable to be considered necessary,” meaning that you don’t have to be forced to purchase the item in order to deduct it. It merely has to be useful or needed by the business.
Note that some goods, services, or raw materials may not be considered “ordinary and necessary” by the IRS and thus non-deductible, even if they are legitimately used for business purposes.
