Today, every small business owner wants to save as much money as possible. The simplest way to do it is to claim all the tax deductions available in the small business expense list. The tax deduction is the main area that small businesses could leverage to lower their taxable income. This article will list down top small business tax deductions that will help you save up a significant sum of money, but let us briefly explain what tax deductions are.
What Are Tax Deductions?
Also known as the “Tax write-offs, “tax deductions are the allowable expenses that businesses can avail of to cut down their taxable income. The IRS (Internal Revenue Service) taxes small businesses and companies based on their net income. By claiming more tax deductions in your taxable income, you can save a significant sum of money that could be used to expand your business and revenue further.
In simpler words, Tax deductions are regular business expenses that are meant to allow you to pay smaller tax bills and save up precious money. Some of the most common tax-deductible expenses include startup costs, the cost of using the vehicle for business, advertisements, etc.
Note that some business expenses are not tax-deductible. To claim these deductions, one must keep accurate and detailed records of their accounting reports. It would be best if you consult your tax advisor before you claim any deductions to avoid mishaps.
If you do not have a good DIY bookkeeping setup, you can hire virtual accounting service providers like Overdraw to avail of the best online bookkeeping services. We can handle your accounting for a stimulus check before you claim tax deductions.
Types Of Small Business Tax Deductions
Here is a list down of all types of small business tax deductions along with their introduction.
- Business meals
- Business insurance
- Advertising and promotion
- Bank fees
- Use of vehicles for business
- Home office
- Professional and legal fees
- Moving expenses
- Rent expense
- Salary expenses and benefits
- Licenses and taxes
- Internet and telephone expenses
- Travel expenses
- Bonus: Personal expenses
Business owners can avail of a total 50% deduction on business meals provided to their employees. However, there are certain criteria that owners have to meet to avail of this deduction.
Firstly, the meal provided should be necessary and ordinary to carry on the business. Also, the meal shouldn’t be too costly and lush, and both the business owner and employees should be present at the meal. The business owner can’t deduct the amount spent on meals for himself.
Let’s take a late-night shift as an example. The meal that you provided to the employees on that shift is a 50% deductible. However, if a business owner provides a meal to the employees on a business trip or picnic, that amount is utterly deductible.
A business owner must keep detailed documentation of the meal provided; these documentations should include details like the amount spent on the meal, where the employees and owner had the meal. However, to avail of this deduction, it is essential that the person you’re dining with, and you should be in a business relationship. In any other case, the expense would not be considered deductible.
An effective approach to keep such records is to note down the purpose and topic of discussion at the meal on the back of its receipt.
Small business owners usually pay insurance premiums to ensure their business operations’ security in case something disastrous happens. These premiums could be claimed and deductibles when you file a tax return.
- Insurance premiums covering business liabilities
- Insurance premiums cover business assets like property, equipment, and furniture, etc.
- Premiums paid for employees’ health insurance, for example, vision and dental insurance.
- Malpractice insurance.
- Insurance premiums on vehicles used for business purposes
- Compensation coverage for workers.
- Life insurance covers employees unless the business owner or the business itself is a beneficiary of the policy.
- Business break-ins that cover lost profits due to disaster conditions cause the business to shut down like fire break-ins, Earthquakes, etc.
Advertisement And Promotion
As business owners, we all need to promote our businesses through effective marketing strategies. However, the amount we use to promote our businesses and services could be deducted from taxable income. The advertisement expenses that you can claim for deductions are
- The purchasing cost of ad spaces in both online and print media.
- The amount that a business owner spends on digital marketing campaigns
- Cost of building up and launching a website
- The amount a business owner has spent on sponsoring a business dinner
- Expenses incurred on printing brochures and cards
- Amount spent making business logos and the fees paid to a designer if you have hired one for the job.
- Amount spent on the delivery of business cards to clients
Bank transactions run side by side with business operations. However, to execute these transactions, there is a certain amount that an account holder has to pay to the bank. These include bank interest on both an annual and monthly basis, transfer and overdraft fees, etc. Business owners can claim this cost as deductibles from their taxable income. Similarly, the expenses incurred on the third-party payment gateways such as PayPal are eligible for deductions.
Note that these deductions are limited to the business only, and a business owner is not eligible for such deductions on his credit cards or bank account. Therefore, it would be best to have a separate bank account and credit card devoted to business only to avoid inconvenience.
Use Of Vehicles For Business
Business vehicles are used to conduct business activities like moving inventory, moving employees, and delivering goods, etc. Since these vehicles are used for business purposes, a certain amount needs to be spent on their maintenance, fueling, repair, etc. If not deducted, this amount could impact your earnings significantly, especially in this time of novel Coronavirus pandemic. Therefore, it is important to know that these expenses incurred on business vehicles are eligible for deduction when you’re filing your tax returns.
While you plan to claim deductions on cost spent on business vehicles; there are two approaches from which you can follow one, the Actual Expense method and the Standard Mileage method. Let us briefly explain both.
Actual Expense Method
With the Actual Expense method, you have to keep track of all the expenses incurred on a business vehicle throughout the business year. These expenses could be the amount spent on registration, lease payments, and all the expenses incurred on maintenance like oiling, fueling, repairs, tires, etc.; the sum of all these expenses is then multiplied rate of miles driven by the vehicle for business purposes.
Standard Mileage Method
The second method to calculate tax deductions on a business vehicle is the Standard Mileage method. Using this method, a business owner has to multiply the total miles driven by a vehicle for business activities with the standard mileage rate. This amount can be deducted then from the taxable income. The standard mileage rate set by the IRS for 2020 is $0.57 per mile. Back in 2019, the standard mileage was $0.58 per mile.
Both of these methods require a business owner to use the total miles driven by vehicle for conducting business activities; it is essential to record a mileage log for business vehicle. This log should include important details like the miles driven on the vehicle for business activities, the trip’s purpose, and the place vehicle had been driven to. Since these details are tough to maintain, a business owner can pursue ideas like having an app to maintain these records.
However, one thing to know is that amount spent on only business activities is deductible. Miles driven by a vehicle from home to the business location and vice versa are not eligible for deduction since they are considered personal expenses.
When you purchase assets like equipment, furniture, and other business assets, depreciation on these assets will occur over the years as per the depreciation rules. According to the rule of depreciation, these assets’ cost would not be deducted in an instant. Instead, these assets will depreciate slowly over time with the use.
To avail of quicker tax deduction, it is a good idea to expense these assets upfront. IRS has provided several methods to deduct the total depreciation cost of assets in one year. These are
De Minimis Safe Harbor Election
Business owners can deduct the items that cost less than $2500 per item in the year they were purchased through an election.
Section 179 Deduction
Property placed in business services could be deducted up to $1 million during the tax year through Section 179 deduction. This method includes both new and used business property, including the software as well. This is quite a convenient method since it allows the owners to deduct depreciation on assets carried forward in the next year’s tax returns.
Bonus Depreciation Method
Small business owners can deduct even 100% of machinery, furniture, appliances, and equipment by leveraging the Bonus depreciation method.
Let us take a business vehicle as an example. A business owner purchases a new vehicle during the tax year. Since IRS (Internal Revenue Service) has limited the number of deductions for passenger vehicles, if you don’t claim bonus depreciation, the maximum deduction could go up to $10,000.
In contrast, if you claim the bonus depreciation, the maximum deduction on depreciation could go up to $18,000.
Depreciation of assets is quite a complicated subject. You can read our conclusive guide on depreciation and its calculation to increase your knowledge on the subject.
Business owners always want to increase their overall productivity since it goes hand in hand with the profits. To increase the overall productivity, business owners opt to conduct educational seminars and classes to expand their employees’ technical knowledge of their business. This amount spent on such educational purposes could be deductible if it meets the IRS’s certain criteria.
- Webinars and seminars related to your business
- Books relevant to your business niche
- Workshops that increase the skills and expertise of employees related to your business itself
- Amount spent on transporting employees to and from these educational classes
Business owners must know that if these classes are related to anything outside their business or even qualify their employees for a new career, the expenses incurred on such education are not eligible for deductions.
There are times when a business owner has to conduct some or entire business activities from home because of certain reasons. The biggest example of a home office could be found in this pandemic caused by the Covid-19. Since the expenses incurred on personal property are not deductible, business owners might be worried about not claiming deductions. There are quite a few ways to avail of deductions on home offices against the business income. These methods include
With a simplified method, you’re able to deduct a maximum of 300 square feet of your home space used for business purposes for $5 per square foot.
With the standard method, you have to keep track of all expenses required to maintain your home. These expenses include rent, mortgage interest, real estate taxes, housekeeping, repairs, landscaping, homeowner’s association fees, and all types of utilities. You have to multiply then the percentage of your home used for business activities with these expenses.
Using these methods, a business owner can easily deduct the taxable income; however, they should meet the following requirements.
Principal Place ForConducting Business Activities
You can quickly guess this one with the name. Your home office should be the principal place for conducting your business activities. This means the business owner has to spend most of his time conducting significant business activities from there.
Regular and Exclusive Use Of Home Office
To qualify for home office deduction, your home office must be used regularly. Also, it must be used exclusively for conducting business activities only. This doesn’t mean that you have to devote an entire room for your business, but the area should be considerable enough to identify the boundaries.
It is recommended to attach the home office workspace photos as evidence of your tax filings when claiming home office deductions.
When claiming deductions on the home office using the standard method, one has to file Form 8829 alongside the schedule C
Credit cards are common when conducting business transactions; however, the credit card companies and lenders charge interest on the use of these cards, which can also be deducted from the taxable income. To claim deductions on sich interest
The Lender and Business Owner Intend For Debt To Be Repaid
The loan which is intended to be paid by the business owner is eligible for deduction. In case of situations like loan forgiveness, where a business owner doesn’t have to pay any loan, no amount is deductible as it is considered a gift.
Business Owner Must Be Legally Liable For The Debt
The name says it all; you are only eligible to claim deductions on a loan that you’re liable to pay. Even if someone from your family took a loan to help you start a business or purchase machinery and equipment required to conduct business, you can’t claim deductions. The condition applies even if you have paid the entire loan by yourself.
True LenderAnd Debtor Relationship
The Internal Revenue Service (IRS) tends to research loans between the debtor and the lender. You are not eligible for deductions unless the payment is made if you’re using the accrual accounting method.
Suppose the amount of loan is being used to meet both personal and business expenses. The business owner has to divide the interest rate between both entities depending on each amount.
Professional And Legal Fees
A business owner solely cannot handle the accounting and bookkeeping for the whole company. Similarly, under certain conditions, a business owner has to hire lawyers as well. The amount spent by owners for these accountants and lawyers is eligible for deductions. However, in some cases, this amount also includes the expenses made for personal use, like the vehicle’s transfer of personal property. In such cases, these personal expenses should be excluded from the deduction as you can only claim the deduction for business expenses.
The Tax Cuts and Jobs Act excluded the deduction of expenses made for moving material for all non-military organizations back in 2017. However, business owners can still avail of the deductions on the amount spent on moving expenses like moving office supplies, equipment, machinery, etc., from one business location to another.
To avail of such deductions, a business owner must have records of all the costs related to moving expenses.
Many small businesses, especially startups, do not have the workspace of their own. These workplaces and business locations are often rented, due to which the amount of overall profit is significantly affected. Business owners can claim deductions from the Taxable income as rental expenses. However, the rental cost for only the business locations can be deducted. The rent paid on your home would not be deducted. If you’re using a home office, that rent could only be deducted as a home office expense.
Salary Expenses And Benefits
Salary expenses and benefits are also deductible from taxable income. Even the vacation and picnics accommodated for employees can be qualified as deductibles. However, there are certain criteria set by the IRS for such deduction.
- The salary provided to the employees must be reasonable.
- The services for which the salary has been given were provided.
- The employee shouldn’t be an LLC member (Limited Liability Companies), a business partner, and a sole proprietorship.
Taxes And Licenses
To conduct a business, a business owner has to purchase certain licenses depending upon the business type. Also, there are several entities for which the tax has to be paid. However, the money spent on these licenses and taxes is deductible. These include.
- Payroll tax
- Property tax
- Real estate taxes paid for a business property like warehouses and business locations
- Sales taxes
- Excise taxes
- Fuel taxes
- Business license
- state income taxes
Internet And Telephone Services
If you’re running a business, you must know how crucial it is to have a good internet connection and telephone service is, and they come with a deductible price.
One thing to know is that the only amount deductible here is for the internet and telephone connection you have on your business location. Therefore, to avoid inconvenience, you should have a second landline and internet connection dedicated to your business activities only.
There are business owners who use the same internet connection and telephone line for both business and personal uses. If such a situation occurs, the amount is still deductible but only for business usage. In case the IRS plans to audit, it would be best if you keep detailed records of and bills to prove the amount of business use of internet and telephone.
Business owners have to travel between different cities and countries to conduct important business activities like attending meetings and presentations, etc. The expenses incurred during such business trips could be deductible from the taxable income. To claim deductions on travel expenses, you have to ensure that the trip should be longer than a day and requires you to have rest or sleep on the way.
Deductible business expenses approved by the IRS include
- Shipping of baggage, display materials, or samples to the destination.
- Traveling to and from your business location via a bus, plane, train, or car.
- Parking and toll fees
- Use of car while at a business location
- Meals and lodging
- Dry cleaning while on business trips
- Calls made for business purposes
- Other ordinary and necessary expenses on a business trip
To get these expenses deducted, it is essential to keep all the bills related to each expense. These details include the dates of departure and return and the name of the people you met with. In case you’re using your vehicle, you should also note a mileage log of miles driven.
Personal Expenses Deduction
Tax deductions mentioned above were meant for small business owners. You can avail of them via Form 1065 or Schedule C.Apart from these tax deductions, there are a couple of deductions that these business owners can claim to deduct on their returns. They are
Contributions Made For Charity
While business earns you a great fortune, it is important always to look around and contribute to unfortunate people’s welfare and charity.
Even though the LLC members (Limited Liability Companies), sole proprietorships, and partnerships cannot deduct contributions made for charitable causes as a business expense, these deductions could be claimed by the owners individually through Schedule A.
However, to claim such deductions, the charitable contributions must be made to a qualified organization. Note that Schedule A should be attached with Form 1040 to claim this deduction.
Child And Dependent Care Expenses
If a business owner pays someone to take care of his child or another dependent while he conducts his business activities, then the child and dependent care credit could be claimed. However, the person receiving this credit must be a child (under 13 years of age), spouse, or someone mentally incapable of self-care.
Depending upon your income, the worth of credit is between 20% and 35%. For one dependent variable, the allowable expense is limited to $3000, which goes up to $6000 if you paid for more than one dependent.
Here, you’ll need to attach Form 2441 with Form 1040 to claim the deduction.
It is always great to value your employees while they serve your business over time. Business owners often make contributions to employees’ retirement accounts, from which the amount is given out as pension to the employees who have retired from their services to the business. Such contributions are eligible for the deduction, which you claim by attaching Schedule 1 with Form 104.
Health Care Expenses
Many business owners also contribute to the healthcare expenses of their employees. Especially in these pandemic times, many business owners have suffered the withdrawal of money from the business for employees’ healthcare expenses. The amount spent on these expenses is deductible as well.
By attaching Schedule 1 to Form 1040, business owners that self-employed can claim the deductions on health insurance premiums for themselves and their families. However, these expenses are not deductible if they are coming in through your spouse’s employer.
By reading this comprehensive list of small business deductions, you’ll be able to save quite some money on tax this year. However, claiming these deductions is a tricky and complicated task. We’d suggest you read our article on adjusting entries and other such topics to increase your knowledge of such accounting subjects and avoiding unnecessary penalties.