Private Practice: Tax Deductions

Obviously, an added complication of private practice is sorting out the tax issues involved. I am no expert, here, and am just beginning to get an idea of everything involved, but I thought I'd start to share what I'm learning. First off: tax deductions.

Tax deductions are expenses the government allows to be deducted (subtracted) from the amount of annual income on which you are required to pay taxes. The more you are able to deduct, the less you pay in taxes. When it comes to business expenses, the theory is that you do not pay income tax on the amount of "income" that is really just recouping money spent to make the income. So if I have to spend $5 to make $100, only $95 is "real" taxable income.

So, what expenses are tax deductible? In general, any expense that is considered "ordinary and necessary" to running a business - ordinary meaning that professionals in general would agree that it is a relevant business expense, and necessary meaning that it furthers business objectives. Note that expenses to start (rather than run) a business are considered capital expenditures, and not deductible as business expenses. 

Examples of deductible expenses are advertising, office expenses, supplies, and utilities, insurance, legal/professional services, and rent. Examples of nondeductible expenses are professional examination fees, commuting expenses, fines/penalties, and personal expenses.

When something is used for both business and personal purposes (e.g., your cell phone), the expenses has to be split (“allocated”) between personal and business on a reasonable and consistent basis. Obviously, you can only deduct the business portion as a business expense. 

A special case is the home office. The IRS is pretty stringent in its requirements for a home office. Basically, for a therapist to claim a home office s/he would have to see clients there, use the space exclusively for business, and as the primary place of business. Unless you see your clients in a dedicated office attached to your home, you won't be able to claim a home office. 

To substantiate deductions, you also need to have receipts or cancelled checks to show that the expense was actually paid, within the relevant tax year. It's important to keep good records for expenses, in addition to client records!

I'm hoping people will leave comments with their own knowledge of deductible and nondeductible expenses and how you handle taxes in private practice!