Owning your business is one of the best way to save on taxes. When you are a W-2 earner, you pay taxes on every dollar earned. As a business owner, you only pay taxes on your net profits. Your net profit is the difference between what you bring in and what you spend in building your business. This means you owe taxes on what is left and not all you made.

For a business expense to be deductible, it has to meet these 3 conditions:

• The expense must be ordinary and necessary for your business or profession
• The expense must be directly related to your business – this means not a personal expense
• The expense must be for a reasonable amount – beware of lavish meals and entertainment expenses

How to deduct your business expenses

How you deduct your business expenses depends on what type of business entity you operate. Whether you are a sole proprietor, C Corporation, S Corporation or partnership, you are allowed deductions before arriving at net income.

Sole proprietor

If you are a sole proprietor, your business expenses are deducted on Schedule C. The net profit is transferred to your form 1040. Your business income is also subject to 15.3% Social Security and Medicare taxes. Paying social security and Medicare taxes is not all bad as this is money that comes back to you when you are 65 and older. You also have to pay federal taxes and depending on your state, pay state taxes too.

However, if you have a loss on your business (that is expenses exceed income), you do not have any income to pay taxes on.

C Corporation

If you own a corporation, you file your taxes on form 1120. Your expenses are also deducted on form 1120. Your corporate tax return is taxed separately from your personal tax return.

S Corporation

An S corporation files a separate tax return on form 1120S but unlike a C corporation the income flows through to your personal tax return. However, unlike the sole proprietorship you do not have to pay self-employment taxes on the income that flows through to your personal tax return. A S Corporation deducts expenses on form 1120S.

A partnership

If you are going to into business with a partner and you do not want the hassle of incorporation, then you can form a partnership. Forming a partnership is as easy as forming a sole proprietorship. You will need to file a separate tax return on form 1065. Your expenses are also deducted on form 1065. Your share of partnership net income flows through to your personal tax return. Partners are not employees and do not get W-2s. Rather than a W-2, they should get a schedule K-1.

LLC

As a LLC you can choose to be taxed a corporation, s corporation, sole proprietor or partnership. See above on how to treat your deductions depending on what entity you choose.

Regardless of what form you choose to operate your business, starting your business is one of the best ways to save on taxes because you do not pay taxes on every dollar earned.