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Small business owners often look to tax time with dread, but thereâs no need to overcomplicate a small business tax return. One way to make sure your business survives tax time with as little out-of-pocket expense as possible is to stay informed about the tax deductions available to you.
In this article, we take a closer look at the tax deductions that are commonly overlooked by small business owners. To confirm if some or all of the deductions listed below apply to your income tax return, consult with a tax professional.
Why are tax deductions important for your small business?
Tax deductions occur when certain business expenses are deducted from taxable gross income. Reducing the amount of income that the federal government can collect tax on can decrease the amount a business owner owes or increase the amount of refund owed to the taxpayer. Taking advantage of all the right tax deductions is key to maximizing your small businessâs profitability and can save you significant cash.
Small businesses can include partnerships, LLCs, sole proprietors, independent and self-employed contractors, freelancers, and some corporations. Each business structure may qualify for its own tax deductions, and the correct forms used to file income tax returns also vary.Â Most sole proprietors, partnerships, and LLCs file an individual tax return and include a Schedule C for business income and expenses, while corporations file a corporate tax return. Working with a certified public accountant (CPA), or another tax professional, can provide the information you need about which forms to use when filing a business tax return and which of your business expenses are deductible.
Ordinary operating expense deductions
Expenses cover any costs an individual or business occurs. A business calculates its net income by subtracting total expenses from the total revenues. On an income statement, actual expenses may be broken down into two categories:
- Operating expenses â Includes ordinary daily operational expenses like payroll, rent, insurance, supplies, and depreciation.
- Non-operating expenses â Expenses that do not affect daily operations like mortgage or loan interest and income taxes.
The following tax deductions apply to the operating expenses paid throughout the year for a small business.
The money spent to start a new business is categorized into either startup costs or organizational costs. Startup costs are the expenses incurred when starting a trade or business or for the investigation costs to create or buy an existing business. The term, organizational costs, refers to expenses for starting a corporation, LLC, or partnership and includes fees for forming the entity and registering the business.
Most startup and organizational costs are considered capital expenditures, not expenses, but the IRS allows small business owners to deduct up to $5,000 of each type of startup cost in the first year of business. If startup or organizational expenses are more than $50,000, the $5,000 deduction is reduced.Â The remaining costs, above the amount deducted, are then treated as capital expenditures and amortized over several years.
Retirement plan contributions
Many individuals count on a retirement plan, like a 401K or IRA, to help them plan for the future. Businesses have the option to contribute to the plan for the employees and for business owners.Â The amount of funds a business can contribute to the ownerâs own plan or to their employeeâs plans is determined by the IRS. A small business owner is currently allowed to contribute $57,000 each year to retirement plans. Contributions to their own plan or contributions intended to match employee contributions are all tax-deductible up to a predetermined limit.
Small business owners grow their businesses through great products and word-of-mouth, but most businesses also spend some time and money on marketing. The costs to advertise and promote a business are fully tax-deductible. Expenses for hosting a website, creating brochures, guest blog posts, radio advertisements, and more are all eligible for a tax deduction. Marketing and advertising expenses can be hard to classify, but in short, if it helped to get the word out about your business and is exclusively related to your business purposes, it is deductible.
Insurance premiums paid for business policies are tax-deductible. Most small businesses require a general liability insurance policy at some point, but other insurance policies like health insurance, workerâs compensation, and even the Directors and Officer (D&O) policies are deductible.
Depreciation is the term that describes reducing the value of an asset over time. Different assets are depreciated over different lengths of time, or the useful life of the asset. The amount of the assetâs cost that is expensed as depreciation in a tax year is deductible when claimed as a write off on IRS tax Form 4562. The process of depreciation also allows business owners to write off a cost of a capital asset, so some business owners choose not to take these business tax deductions.
Some taxpayers and entrepreneurs do not realize that many taxes are also tax-deductible. The following list is just some of the taxes that can reduce your overall tax liability.
- State income taxes
- Personal property taxes
- Social security taxes
- Commercial real estate taxes
- Sales tax
- Employment taxes
- Payroll taxes
Home office deduction
As we navigate the ânew normalâ in the post-pandemic economy, many professionals that were accustomed to a 9 to 5 office day are now working out of their home. Whether working from home is new to you or youâre a small business owner that runs your business exclusively from a home office, you may be wondering which of your home office expenses are tax deductible. The answer is not as simple as âyes or no.â
If you are employed by someone else and working remotely, you can no longer deduct any home office expenses. However, if you are a small business owner, many of your home office expenses are deductible if they are for business use. According to the IRS, if you are deducting home office expenses you must meet the following requirements:
- A portion of the home must be regularly and exclusively used for business.
- The home office must be the principal place of business.
If your home office qualifies for tax deductions, you can calculate the expense deduction with either the simplified or the regular method. The simplified option gives a rate of $5 per square foot for up to 300 total square feet and the regular method bases the standard deduction on the percentage of the home that qualifies as a home office.
Travel, meals, and entertainment
A portion of the expense of meals and entertainment for your business also ends up qualifying as business deductions. Generally, small business owners can deduct up to half of food and beverage costs if the meal is an expense of their business. Meals with clients or team lunches that the business owner physically attends will usually meet the requirements for the deduction, but the taxpayer must be able to prove the meal wasnât extraordinary or lavish and was business-related.
Travel expenses for business trips follow similar rules to meals and entertainment, although up to 100% of most travel expenses may be deductible. If an employeeâs personal vehicle is used for business travel, they are eligible for reimbursements for either gas and tolls or a standard mileage rate from their employer. Business owners that use their own car, though, may be eligible for tax deductions or tax write-offs. To successfully deduct travel costs, the taxpayer must show that the travel was a necessary cost of running the business.
Deductions most often forgotten
Legislation with regard to business taxes is always changing. As new rules are applied about what is deductible and what is not, understanding these less common deductions can save you big money in the upcoming tax year.
It is not uncommon for small business owners to hire freelancers to complete projects or prepare documents. For example, if you hire a business writer to prepare a professional business plan or create an eBook, the money paid to the freelancer is deductible. Other examples may be money paid to an accounting consultant to prepare a budget or update the books from prior years.
Carrying charges are taxes and expenses paid for developing real estate and carrying, transporting, or installing personal property in a small business. The fees and interest expenses on a loan may also be classified as carrying charges where there is personal property or real estate involved. Most carrying charges are required to be depreciated over the useful life of the asset as a capital expenditure, but the IRS considers some of these expenses, like sales tax and banking costs, to be deductible.
The costs of legal or professional fees for your business can be counted as tax deductions. For example, hiring an attorney to rewrite the docs and bylaws of a condo association or nonprofit organization is deductible. Other professional fees that are deductible may include, financial planners, tax professionals, bookkeeping costs, and business and management consultants. The IRS considers consulting costs to be tax deductions if they are necessary and directly related to the nature of the business.
Best practice tips for small business income tax returns
Whether youâre filing your first business tax return or your twenty-first return, it does not have to be a stressful process. Familiarize yourself with the expenses that are eligible for deductions, like the ones listed throughout this article and these more common deductions:
- cell phones
- moving expenses
- student loan interest
- office supplies
- childcare expenses
Once youâve grasped the concept of deductible expenses, take note of the following tips to file a successful return, maximize tax deductions, and reduce your tax liability.
Keep track of expenses
Keep paper or electronic copies of receipts, invoices, and credit card statements for all business expenses and charitable contributions. If you arenât sure whether the expense is tax-deductible, it wonât hurt to have the documents. Use accounting software or a spreadsheet to record the expenses and help categorize the expenses.
Review last yearâs tax return
Some tax preparers offer a service to review your previous returns and provide tax advice. Looking over past returns is helpful because it allows you to capture any missed deductions which can be used to amend prior returns or adjust current year expenses. Reviewing previous returns also helps in the planning process for handling tax deductible expenses in the future.
Do not wait until the tax season deadline to start analyzing last yearâs deductions. For each year that you are in business, go into the year well-prepared. Start early by organizing documents, and considering deductions when making investing, purchasing, and operating decisions. Check with your tax advisor to learn how you can earn more tax credits in the coming year.
Consult with a tax professional or CPA
Income taxes and deductible expenses can be overwhelming subjects for even the most seasoned business owner. Donât tackle the process alone, reach out to a CPA, tax preparation expert, or financial advisor early to take advantage of all the tax breaks you may be eligible for.
Filing income tax returns as a business owner can be an intimidating process. To make it easier, throughout each calendar year, keep track of ordinary business expenses, home office expenses, and less commonly deducted expenses like carrying charges. Understanding the importance of deductible expenses is the best way to reduce your businessâs taxable income and save you money. However, if youâre facing a hefty tax bill donât be afraid to reach out to a lender and explore small business financing options. Debbie Elder from Texas was able to get her educational business back on track in no time at all after receiving funding directly to her bank account. If you have any financing concerns, check out Biz2Credit today.