Many business owners try to save money anywhere they can. As a result, one area they should pay close attention to is tax deductions.
Figuring out which business expenses you can deduct from your taxable income can save you big. Therefore, it’s important for small businesses to consult accountants and CPAs to ensure they’re maximizing their financial options.
What are business tax deductions?
Business tax deductions are allowable expenses that you use to lower your business’s taxable income. That being said, these deductible business expenses are often referred to as tax write-offs.
The IRS taxes businesses on their net income, which subtracts your business expenses from your gross income. For instance, operating expenses are often tax deductible, but it’s important to note that some are not.
How do business tax deductions work?
Most small businesses operate as a sole proprietorship, partnership or limited liability company (LLC). Also, these entities are required to file a separate tax return unless the company operates as a single-member LLC. Small business tax deductions are reported on the business tax return, reducing the amount of taxes the business has to pay.
According to the IRS, to be deductible, a business expense must be both ordinary and necessary. Therefore, an ordinary expense is one that’s common and accepted in your trade or business, while a necessary expense is helpful and appropriate for your trade or business. If your business expenses align with IRS requirements, you can claim them on the business tax return and lower your business’s taxable income.
How can small businesses maximize tax deductions?
It’s important for small businesses to find out which tax deductions are acceptable in their industry. However, tax codes and laws can be challenging to understand, so you’ll want to consult a tax professional who can provide expert insight into which deductions your business can and cannot claim. Remember, what was allowed in a previous tax year may not be deductible in the current tax year.
Many small businesses hire a bookkeeper or an accountant to help them stay up to date with federal, state and local taxes. By storing receipts, using debit or credit cards, and separating your business bank account from your personal bank accounts, you can help maximize your tax deductions and keep good records of all your business expenses.
What small business expenses are deductible?
Many business expenses are deductible, but as every company operates differently, available deductions for one industry may not be considered necessary expenses in another. It’s far easier to speak about deductible expenses in terms of what isn’t deductible – but let’s start from the beginning.
- Home office: If you use a portion of your home exclusively and regularly for business, you can deduct certain expenses for the business use of your home. These expenses may include rent or mortgage interest, insurance, utilities, repairs, and depreciation. You should know the square footage of the space that you use exclusively and regularly for business as well as the total square footage of your home to calculate the office deduction.
- Startup costs: If you paid expenses related to the creation of an active trade or business, you can deduct up to $5,000 in startup costs for your first year of business. Startup costs include advertising, employee training, supplies, and other expenses you paid in the process of creating a new active trade or business. This deduction is limited in the event that you paid more than $5,000 in startup costs. Costs over this0 threshold must be capitalized over a 15-year period.
- Organizational costs: The same rules used to determine the deduction for startup costs can be used to deduct up to $5,000 in organizational costs in your first year of business. This amount is in addition to the $5,000 deduction available for startup costs. Organizational costs include the expenses of forming your business structure, such as fees for forming a legal entity.
- Interest: If you borrowed money to cover your startup costs and/or to operate your business, the interest you paid is deductible.
More small business tax deductions you need to know about
Don’t worry, there are many more deductibles – we’ve already done the research for you. This complete list of small business tax deductions will make filing your tax return much simpler.
This deductible is for businesses that require the use of a motor vehicle in order to function properly. It’s best to check your vehicle owner’s manual to know which maintenance services your warranty covers. Some reimbursements are null and void with evidence of lack of vehicle maintenance. There are two general methods for deducting vehicle expenses:
- The expense method requires you to track all the costs of operating your company vehicle for the year, including gasoline, oil, repairs, new tires, insurance and registration fees. Then, multiply these business expenses by the percentage of miles driven for business.
- The standard mileage deduction is a simpler method. Just multiply the number of miles driven for business for the year by the standard mileage rate. The IRS says that the standard mileage rate for the use of a vehicle (cars, vans, pickups or panel trucks) in 2019 was 58 cents per mile driven for business use, 20 cents per mile driven for medical or moving purposes, and 14 cents per mile driven in service of charitable organizations.
Salaries and wages
If your business operates as an LLC, you may not be able to deduct income you take from your business; however, the salaries and wages you pay to your employees are deductible.
Work opportunity tax credit
The federal work opportunity tax credit is available to employers for hiring target groups that have faced barriers to employment, such as ex-felons, qualified veterans and Supplemental Security Income (SSI) recipients.
Office supplies and expenses
This office deduction covers small business expenses ranging from desks and chairs to paper and ink. Even if your business doesn’t have a traditional office space, you can still deduct office supplies and expenses so long as the supplies are used within the year of purchase. In many cases, you can deduct the cost of postage, shipping and delivery services as well.
Many businesses use freelancers, independent contractors and self-employed individuals to support their workforce. The cost of this contract labor is deductible. Form 1099-MISC is an IRS form that taxpayers use to report non-employee compensation. Use the form to report miscellaneous compensation, such as prizes, awards, healthcare payments and attorney fees.
The cost of transportation and lodging is fully deductible. In other words, you must meet IRS requirements as listed in Publication 463 to claim any travel deductions.
You can deduct numerous taxes and licenses related to your business. Here are some examples:
- Business licenses
- Fuel taxes
- Sales tax
- Real estate taxes paid on business property
- Payroll taxes
- Personal property taxes
- State income taxes
Child and dependent care expenses
You can claim the child and dependent care expense credit if you pay someone to care for your dependent (a child under the age of 13 or a spouse or other dependent who isn’t able to care for himself or herself). The credit can cover up to 35% of your expenses. To qualify, you’ll have to file Form 2441 along with Form 1040. For more information, refer to Publication 503.
Computer software deduction
Under the IRS Section 179 deduction, you can deduct the full cost of business software as a small business tax deduction, rather than depreciating it as in previous years. This includes POS software and any other software used to operate your business.
Retirement plan contributions
You can deduct contributions to employee retirement plans as business expenses. Therefore, small business owners who contribute only to their own retirement funds claim the deduction on Schedule 1 attached to their Form 1040.
If you’re a self-employed individual calculating your retirement plan compensation, you must calculate self-employment tax by the amount of your net earnings. You can learn more about calculating your own retirement plan contribution and deduction here.
Each insurance premium you pay for coverage on your small business is potentially tax deductible. To qualify, your insurance must provide coverage that’s “ordinary and necessary.” This could include the following:
- Workers’ compensation insurance
- Long-term care insurance
- Health insurance
- Automobile insurance
According to the IRS (Publication 970), there are several new deductions and tax benefits for education.
- Tuition and fees deduction: This deduction extends to qualified education expenses paid in 2018, 2019 and 2020.
- Qualified tuition program: For distributions made from QTPs after 2018, qualified higher education expenses may include certain expenses required for a beneficiary’s participation in apprenticeship programs, and no more than $10,000 can be paid as principal or interest on a qualified student loan of the designated beneficiary.
- Standard mileage rate: If you claim a business deduction for work-related education and you drive your car to and from school, you can deduct 58 cents per mile driven from Jan. 1 to Dec. 31, 2019.
The Tax Cuts and Jobs Act eliminated most small business tax deductions for entertainment purposes in 2018 under Section 274. Recently, the IRS issued a notice clarifying that taxpayers can continue to deduct 50% of eligible business meal expenses. Meals and entertainment expenses can be 100% deductible if they are compensation to employees or income to non-employees.
Because if you rent office space for your business, the cost is fully deductible.
Costs for electricity, phone, internet, water, gas, heating and other utilities for your office or place of business are fully deductible.
Legal and professional fees
Accountant, attorney and licensing fees are some of the many legal and professional fees that are fully deductible.
If you have business debt, you can deduct the interest paid on the loan. According to the IRS, there are two types of bad debts – business and nonbusiness.
Business bad debts are deductibles on the business tax return of the taxpayer as an ordinary loss and can generate a net operating loss. These may include personal investments, activities or personal loans that are in default.
Call Williams & Kunkel CPA today in Flower Mound at 972-446-1040 to have a chat and find out how you can save money on your taxes as a real estate professional.