Top 10 Small Business Tax Deductions
The Internal Revenue Service offers small business owners a fair number of tax deductions—if you know where to find them. From costs associated with launching your enterprise to the Qualified Business Income deduction that was introduced in 2018, there are many ways to help you whittle down your taxable income.
You can deduct up to $5,000 in start-up costs and $5,000 in organizational costs in your first year of business as of 2018. These deductions apply to expenses paid or incurred after Oct. 22, 2004.
The rules differ if your costs exceed $50,000. The amount you can deduct is gradually reduced if your costs top this number.
Expenses that aren't deducted can be amortized over a 180-month period, which begins when you open your business.
You can write off or amortize costs of market research, employee training, business-related travel, legal advising, and other costs.
The IRS has strict guidelines for deducting educational expenses. Employers can generally deduct employee educational expenses if the courses maintain or improve job-related skills, or if employees need the education to continue in their current jobs.
You can also write off some educational expenses if you're self-employed. Transportation to and from the classes can be deductible, but you can't write off any educational expenses that train you in a new field.
Auto deductions are clearly delineated under IRS rules and they tend to be among the more scrutinized items. Meticulous record-keeping is critical. Keep careful records about where you went and the nature of your business if you use your personal vehicle on the job.
You can deduct vehicle expenses by the mile, using the standard mileage rate, or you can deduct the actual expenses you paid out of pocket, such as for gasoline and maintenance. The standard mileage rate for business purposes is 57.5 cents per mile for 2020 and 56 cents per mile for 2021.
Deducting your actual expenses requires first pinpointing the percentage of miles you drove for business purposes. For example, you can deduct 50% of your actual expenses if you used your vehicle for business 50% of the time, such as if you drove 25,000 miles all year and 12,500 of those miles were business-related.
You also can write off a newly purchased vehicle, even if it's used, through depreciation. The IRS stipulates that personal auto use cannot be written off as a business-related expense, only business use.
Keep an eye out for other IRS tax credit initiatives, too. For example, partnerships and S corporations may be able to take an alternative motor vehicle credit for a fuel cell vehicle placed in service in 2020.
Small businesses can take a single deduction for equipment, including computers, machines, furniture, cars, and a host of other necessities, under Section 179 of the tax code.
The equipment doesn't have to be new as long as it's newly purchased and will be used at least half of the time for your business. Movable equipment generally counts, but real property doesn't. You can claim the deduction when the property is placed in service.
The Tax Cuts and Jobs Act (TCJA) dramatically increased the ceiling on the Section 179 deduction from $500,000 to $1 million beginning in 2018. The phaseout limit for qualifying increased to $2.5 million from $2 million. These terms are indexed for inflation so they can be expected to increase incrementally.
Fill out Form 4562 to take the deduction. You can choose not to take an immediate deduction and instead write off portions of the equipment purchases over several years through depreciation.
Business Meal Deductions
The IRS doesn't mind if you mix business with pleasure—within reason. You can deduct up to 50% of what you spend on business meals.
This deduction used to cover recreation, entertainment, and amusement expenses in general, but the TCJA eliminated the costs of general entertainment from the equation. The deduction is still available for meals, however, if the taxpayer or one or more of the taxpayer's employers are present and the meal is provided for current or prospective customers, clients, or business contacts.
The meals can't be "lavish or extravagant," according to the IRS.
Unreimbursed travel expenses are tax-deductible. Transportation costs such as airfare and lodging can be deducted, as well as half of any meals you pay for while on the road.
You also can deduct expenses for business associates traveling with you, but you can't write off expenses for family members or friends if they accompany you unless they're employees and are professionally involved in the business end of the trip.
The IRS recommends keeping a log of your expenses and receipts.
Partnerships, S corporations, and limited liability companies all require that their members file the business's taxes on their personal returns, including any charitable donations that were taken. Donations are "passed through" to members and shareholders, just like the organization's income.
C corporations are also entitled to corporate deductions for charitable contributions, but these aren't pass-through tax entities.
Individuals can deduct up to 60% of their adjusted gross incomes (AGIs) to qualifying 501(c)(3)charities and foundations beginning in 2018, although lower AGI limits can apply to certain gifts. You must have a letter from the organization verifying your donation if you want to contribute $250 or more and take a deduction.
Check Publication 551 and the Section 179 deduction to figure out how much you can deduct if your business makes a non-cash donation, such as a car or a computer. The deduction will decrease if you've already received a tax break for the donated property or if it's lost significant value.
The costs of advertising and promotions are deductible on Schedule C by sole proprietors when they're directly related to the business.
Legal and Professional Fee Deductions
Sole proprietors can write off fees paid to professionals on Schedule C (or Schedule C-EZ for the 2019 tax year and earlier).
The Qualified Business Income Deduction
The TCJA introduced the Qualified Business Income Deduction in 2018. It allows pass-through entities such as sole proprietors, partnerships, S corporations, and some estates and trusts to shave up to 20% off their qualified business incomes and 20% of qualified publicly-traded partnership income and qualified real estate investment trust (REIT) income.
Only the balance is subject to taxation.
Some limits apply to this deduction as well, however. Those working in certain fields can be excluded from claiming it.
The income limits are $163,300 for the 2020 tax year, or $326,600 if you're married and filing a joint return. Beyond this, the 20% credit begins phasing out or decreasing until the deduction becomes unavailable entirely at incomes of $213,300 and $426,600 respectively.
Internal Revenue Service. "Publication 535 (2019), Business Expenses." Accessed Jan. 10, 2021.
Internal Revenue Service. "Publication 970, Tax Benefits for Education," Page 69. Accessed Jan. 10, 2021.
Internal Revenue Service. "IRS Issues Standard Mileage Rates for 2021." Accessed Jan. 10, 2021.
Internal Revenue Service. "Instructions for Form 8910." Accessed Jan. 10, 2021.
Internal Revenue Service. "Businesses Can Immediately Expense More Under the New Law." Accessed Jan. 10, 2021.
Internal Revenue Service. "IRS Issues Guidance on Tax Cuts and Jobs Act Changes on Business Expense Deductions for Meals, Entertainment." Accessed Jan. 10, 2021.
Internal Revenue Service. "Topic No. 511 Business Travel Expenses." Accessed Jan. 10, 2021.
Internal Revenue Service. "Publication 526 (2019), Charitable Contributions." Accessed Jan. 10, 2021.
Internal Revenue Service. "Publication 535, Business Expenses," Page 47. Accessed Jan. 10, 2021.
Internal Revenue Service. "Qualified Business Income Deduction." Accessed Jan. 10, 2021.
Internal Revenue Service. "Instructions for Form 8995." Accessed Jan. 10, 2021.