- 1). Using your payroll records, add up the total compensation you paid to your employees. Total compensation includes salary, wages, commission, bonuses and any other monies or valuables your employees received. For example, if you rewarded your top salesperson with a gold watch, you can deduct the fair market value of the watch on your taxes.
- 2). Include any paid holidays, vacation days, sick days, personal days and the value of any discounts on your products or services that you've offered to your employees and contractors. Even though your employee was not actually working on these extra days for which you've provided pay, it is still considered payment for services rendered as part of an annual compensation package.
- 3). If you are a sole proprietor, deduct these costs as part of your business operating expenses on Schedule C of your annual tax return. As a sole proprietor, you cannot deduct personal salaries, bonuses or other wages you paid yourself during the tax year. As a sole proprietor or a member of a partnership, you are not considered an employee of your own business.
- 4). Understand that, if your business is a corporation, you can deduct the salary you've chosen to pay yourself as an employee. If your business is a limited-liability company, you may deduct your personal salary if you have chosen to be taxed as a corporation. If you have chosen to be taxed as a partnership, the same restrictions apply (as though your company actually were a partnership). In this case, you would not be able to deduct your own salary and other benefits.
- 5). Do not deduct actual expenses for your employees (such as a mileage reimbursement or car allowance) as wages, but as separate expenses. On Schedule C, report as wages and salary only the actual compensation you paid your employees in exchange for services rendered.
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