You can deduct many types of expenses associated with your business. A deductible business expense must meet the IRS definition of an "ordinary and necessary expense." Ordinary expenses are those that are common to your business or industry. Necessary expenses are reasonable expenses for carrying on your business. An expense does not have to be for something indispensable to be "necessary," nor are you required to choose the least expensive option.
Legal fees and other costs relating to setting up a new business are called "start-up expenditures." You cannot deduct them all in one year; instead, you amortize the costs over several years. For more information, see IRS Publication 535, Business Expenses, on the IRS Web site.
As a sole proprietor of a business, you should keep records of your business expenses separate from your personal expenses. If you have an expense that is partly for business and partly for personal use, you must divide the expense between personal and business use.
Some expenses can be deducted either with your personal itemized deductions or with expenses from your business. You generally receive more of a tax benefit by including any business expenses with your business. Deducting expenses as business expenses on Schedule C, Profit or Loss From a Business, reduces your self-employment income and therefore the amount you pay in self-employment tax. Furthermore, some expenses must exceed a limit before you can deduct them with your personal expenses; however, you can deduct the full amount if you include them with your business expenses.
For example, real estate taxes you pay on your home are deductible as an itemized deduction. But if you qualify to take a deduction for business use of your home, the portion of your real estate tax that corresponds to the business use of your home should be deducted from your business income to reduce your self-employment income. If you deduct an expense from your self-employment income, it reduces your self-employment tax on your business income and your income tax on your total income; if you deduct an expense as an itemized deduction, it reduces only your income tax.
Another example is the fee you pay for tax preparation. If you own a business and you pay an accountant to prepare your taxes, some or most of the tax preparation fee is allocable to your business. If you deduct part of your accountant's fee with your business expenses, you receive the full tax benefit from the expense. However, if you deduct the fee as a miscellaneous itemized deduction, you can only deduct the portion that, along with your other miscellaneous deductions, exceeds two percent of your adjusted gross income. See your accountant for more information.