Most small business expenses qualify as tax deductions, You can cut your business tax bill by taking as many qualified deductions as possible. This article discusses 10 of the most common deductions and how they work.
- Your small business can deduct most common expenses, as long as they are ordinary and necessary for your type of business.
- For some expenses you must separate personal use from business use, because personal use isn't deductible.
- You can't prepay for these expenses; they must be able to be used during the year.
- Some business expenses that can't be deducted in one year can be spread out over several years through depreciation.
How Do Business Tax Deductions Work?
Small businesses can take tax deductions for all ordinary and necessary expenses for operating the business for a profit. But different kinds of expenses are deducted differently.
The types of business expenses are:
- Capital expenses for long-term assets like a company car, equipment, startup costs, and improvements
- Cost of goods sold, the expenses for making, selling, and shipping products
- And all the normal costs of running a business, like the cost of leasing, paying employees and non-employees, office expenses, utilities, and supplies
In this article, we'll look at some common expenses you can deduct to cut your tax bill.
Personal expenses aren't deductible., so you must separate business expenses from personal expenses. For example, you can't deduct expenses for commuting between your home and your business, because this considered to be personal driving.
10 Tax Deductions for Small Businesses
Legal and Accounting Fees and Tax Preparation
You may decide to hire and pay an attorney for legal services or someone to take care of your bookkeeping and accounting, or to prepare tax returns and offer tax advice. These professional services are deductible business expenses.
You can't deduct legal or accounting fees for services in helping with business startup or to acquire business assets, but you can include them in the cost of your business or the asset. If an accountant or attorney is doing your tax return or other work that includes both business and personal services, you can't deduct the personal part of the fee.
Advertising and Marketing Expenses
Whether you call it advertising, marketing or promotion, you can deduct expenses that help you bring in new customers and keep existing clientele. You can also deduct costs for keeping your name before the public, like advertising that encourages people to contribute to nonprofits.
One of the biggest deduction mistakes business owners make, though, is trying to deduct the costs of driving around with an ad for your business on your car. The cost for the ad itself is deductible, but not the cost of driving the car around with the ad on it.
Computers, Tablets, and Cell Phones
You can deduct the costs of purchasing necessary reference materials as well as computer hardware and software. It's no longer necessary to depreciate these items as long the cost isn't more than $2,500.
Only the business use of your computer or iPad is deductible. Computers, tablets, and related hardware and software are not considered listed property as of the 2018 tax year, but you still should be using these devices for business purposes more than 50% of the time.
Use of a Car or Truck for Business Purposes
You can deduct expenses related to business use of your vehicle using the IRS standard mileage rate or by deducting actual expenses.
The standard mileage rate changes each year, so check the rate for the current tax year. Run the numbers both ways (standard vs actual mileage) to see which is best for your business. Keep in mind that there are some restrictions; for example, you can't use the standard mileage rate if you depreciated the cost of your vehicle in previous years.
You can't deduct expenses for commuting to your business location or for personal driving, so you must separate out the personal driving mileage from business miles before calculating the deduction.
If you have purchased insurance for your business, for your business equipment, or group health insurance for yourself and employees, you can deduct premium costs. Other types of insurance premiums you can deduct include:
- Workers' compensation insurance under state laws
- Insurance to cover business expenses if a business owner is disabled
- Life insurance for officers and employees, if the business isn't a beneficiary
- Business interruption insurance if your business is shut down for fire or other causes
Interest on Business Debts
If you have bought a building for your business or you have a business loan, you probably have interest expenses. Small businesses with annual average gross receipts of $25 million or less for the past three years can take all interest expense deductions with no limit.
Starting in 2018, the interest rate deduction for larger businesses is limited to the sum of:
- Business interest income
- 30% of the company's adjustable taxable income
- Floor plan financing interest
Leasing an Office, Equipment, or Business Vehicle
Lease expenses for office space or for equipment is deductible each year, but only for the expense for that year. That means you can't prepay a lease for an additional year and take the deduction for that second year on your tax return for the current year.
You can also deduct the cost of leased vehicle for your business, depending on the type of lease. If the lease is an operating lease for under 12 months, the cost can be deducted each year for the term of the lease. The other type of lease, called a capital lease, is a longer-term lease that has similar terms to a purchase. Capital leases must be depreciated.
Most business vehicles are considered listed property, meaning that you must separate out business use from personal use, and you can only deduct the part of the lease cost related to business use.
Having employees means you can take deductions for most expenses relating to these workers. You can deduct employee-related costs for:
- Wages and salaries
- Tools and equipment
You can deduct costs for employment taxes including workers compensation, unemployment tax, and FICA tax for the employer part of Social Security and Medicare taxes.
Employee benefit costs are deducted in two different places on your business tax return. You'll need to separate for pension and profit-sharing plans from costs for other benefit programs before you enter them on your return.
Business Travel and Meal Expenses
Expenses for business travel are deductible if they involve travel away from your main place of business or work. Deductible travel also must be primarily for business purposes. You can deduct costs for transportation, lodging, taxis or ride-sharing, and miscellaneous expenses like laundry services and tips.
Entertainment expenses are no longer deductible, but you can deduct meal expenses. Most meals can only be deducted up to 50%, and you must prove these for business purposes. Meals while traveling are still deductible at the 50% rate.
The IRS has made a temporary exception to the 50% limit on meals and beverages from restaurants and other businesses that prepare and sell food and beverages, in the facility or for takeout. From January 1, 2021, through December 31, 2022, you can deduct the costs of restaurant meal costs at 100%.
Office Supplies and Office Expenses
Every business needs office supplies and materials such as staplers, paperclips, pens, pencils, etc. These expenses are also deductible for business tax purposes as long as they are used during the year. Be careful to separate out supplies used in making and shipping products and include these in cost of goods sold.
Other expenses for running an office, like internet hosting fees, are deductible. Office equipment like desktop computers and office phones can also be deducted n the year you buy them if they cost less than $2,500.
If you buy office equipment that is useful beyond one year, like professional instruments, books, or equipment, these must be depreciated over multiple years.
The Bottom Line
Most business deductions come with limits, restrictions, and qualifications. Get help from a licensed tax professional when you're ready to do you yearly taxes. You may also be able to use business tax preparation software if you have a relatively simple tax return.
Create a paper or electronic trail for each deduction you claim. Include the date of the expense, the exact amount, and the purpose it served your business in case you have to explain the deduction to the IRS. This can be as easy as saving receipts, bank statements, and credit card statements and making notations on them to remind yourself why the expenses were incurred.
Frequently Asked Questions (FAQs)
What's the difference between business tax deductions and tax credits?
Tax deductions and tax credits both reduce your business taxes, but they are different in value and they work differently.
Tax credits directly reduce taxes dollar for dollar, and anyone can claim their full value. But they can't reduce a business's tax bill below zero to give a loss. Tax credits are usually granted as an incentive for businesses to do something specific. Examples are the Work Opportunity Tax Credit for hiring disadvantaged workers and the small employer health insurance tax credit for paying part of the cost for employee health insurance.
Tax deductions are used to reduce your business income to determine your tax rate. If your business has more deductions than income, you may have a net loss for tax purposes.
How much do tax deductions for business expenses save you?
Each business tax situation is different, and the amount of tax deductions may vary from year to year. Most small business owners pay their business taxes as part of their personal tax return on Form 1040 or 1040-SR (for seniors). In these cases, the business net income is included with your personal income and expenses to determine the taxable income and the tax rate for that level of income.
One way to get a general idea of how much you can save with business deductions is to estimate your total tax using IRS Form 1040-ES Estimated Tax for Individuals. You may also be able to use business tax preparation software to do this estimate.