What Is a Deduction?
A tax deduction, also known as a write-off, is a business-related expense that you report on your tax filing. When the expense meets the IRS qualifications, it can be subtracted from your overall tax bill. In this way, small business owners are better able to handle the vast amount of expenses that are required to run a modern business.
Sounds amazing, right? But you can’t just submit tax deductions and hope they work. This is a transaction with the federal government, not a game of horseshoes. So you’d better confirm your deductions are in order long before you file.
Even the most organized and ethical entrepreneurs are sometimes tripped up by an overlap between their business and personal expenses. In fact, this is probably the most common area for issues with deductions. To help bring clarity, the IRS has prepared extensive resources to help you distinguish between the 2 segments of your life.
“Generally, you cannot deduct personal, living, or family expenses,” says an official posting on IRS.gov. “However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part. For example, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you can deduct 70% of the interest as a business expense. The remaining 30% is personal interest and is not deductible. Refer to chapter 4 of Publication 535, Business Expenses, for information on deducting interest and the allocation rules.”
The bottom line is that compliance is of the utmost importance. Start by familiarizing yourself with the relevant rules, then partner with a tax professional to ensure you’re doing things correctly. An expert will not only let you know when you’re in line but will also be able to identify even better options for the future.
Finding the Right Deductible Expenses
It might seem as though certain small businesses are more primed for deductible expenses. For example, as a freelance writer, my expenses are minimal. So there aren’t nearly as many areas for me to score write-offs as there are for my freelance colleagues who are graphic designers or photographers.
But it would be a mistake for me to assume that there aren’t relevant deductions for my small business. The challenge is just to identify them.
“Benjamin Franklin said it best when he coined the phrase, ‘A penny saved is a penny earned,’” says business finance expert Mark J. Kohler. “Many business owners take years to understand that taxes are one of their biggest costs, and it really doesn’t take a lot of effort to make sure you aren’t missing something on your taxes […] You are the captain of your own ship. You don’t have to be an accountant to manage your accountant. Make sure you have a regular conversation with your tax preparer and discuss these items. Your accountant should be suggesting these to you and they should be trying to find ways to write off expenses—not just telling you no and talking down to you.”
To help you get a better understanding of the general categories of deductible expenses, as well as some prominent examples, we’ve compiled this guide. Read on to learn more about this important way to save money and bolster your business.
Tax-Deductible Expenses for Small Businesses
Enough talk—let’s look at some of the main deductions that are available for entrepreneurs. Remember, every business has its own unique situation. So you probably won’t qualify for all of these deductions. In fact, your ability to receive certain deductions could change year to year. Do your research each year before tax time and never make assumptions.
Advertising and Marketing
Money spent on advertising, marketing, and your other promotional initiatives can help to lower your tax bill next April. There are some exceptions to this rule. For example, if your promotional expenses are related to political efforts, they probably can’t be deducted.
Examples of qualified expenses include:
- Business website design
- Business logo creation
- Printing new business cards
- Printing informational brochures
- Paying for online display ads
- Mailing marketing materials to customers
- Social media ads
It can cost a lot of money to insure your small business. Luckily, those costs can be deductible. Here are some examples of qualified expenses:
- Auto insurance for your fleet vehicles
- Liability insurance
- Business interruption insurance
- Property insurance for your structures or equipment
- Health, dental, and vision insurance for your employees
- Workers compensation
Business Licenses, Permits, and Taxes
Much of the money you spend to start your business and keep it running can be deducted. Examples of qualified expenses include:
- Business license
- Payroll taxes
- Sales tax
- Personal property taxes
- State income taxes
- Fuel taxes
Yes, meals can be deducted in many business situations. Just note that the food can’t be lavish (sorry, lobster lovers)—it needs to be necessary to the ordinary course of your business, and the owner or an employee needs to be present.
Documentation is essential for these deductions. Here’s a pro tip: keep a receipt for every business meal, and then write the date of the purchase, the location of the purchase, and the business purpose on the back.
You can often deduct your expenses related to overdraft fees, transfer fees, merchant fees, or ongoing services charges. You should always have a dedicated business account, as any fees related to your personal account should not be deducted.
Vehicles and Transit
The automobiles used for your business obviously cost money to operate. The good news is that if the vehicle is dedicated to your business, you can deduct all the expenses needed to keep it operating. Things get a little more complex when you use the vehicle for both personal and business purposes.
If you plan to deduct operational costs, you’ll need to track your miles. Apps and software make this much easier than the old manual approach.
If you have a business location, you can deduct the utility costs from your taxes. It’s not as straightforward if you work from a home office, so it’ll be important to work with a tax professional to figure out the best way to handle that situation.
Legal and Professional Fees
The services of accountants, tax preparers, attorneys, and other professionals don’t come cheap. You can deduct those expenses to reduce their impact on your finances.
As with other expenses, the situation is approached differently if some of the costs were for the personal side of your life. You’ll need to partner with an expert to ensure you handle it correctly.
Do you incur rental fees for equipment or business spaces? You probably won’t be surprised to learn that you can deduct these costs. If you work from an office in a rented home, you can’t deduct it in the same way, instead making it part of your home expense deductions.
Home Office Costs
If you’re working from home and not paying rent for an outside business location, you can either deduct a determined amount of money for every square foot of your home that is used for the business, or you can break down individual expenses such as utilities, taxes, or HOA fees.
“This one may sound obvious, but many people miss out on this area,” says financial planner David Rae. “When you order paper or ink cartridges from places like Staples or Office Depot, you are pretty aware of the fact that you are buying office supplies. When you stroll through a Target and throw some office supplies on top of your otherwise full cart, will you remember to deduct those expenses? Take the extra few minutes to separate the business purchases from the personal expenses. Put them on a separate receipt and pay with a business-specific credit card. Believe me, when tax time rolls around, you won’t remember what was or wasn’t a business expense.”
Always strive for accuracy in your home office deductions. If you get careless or greedy, you could pay a stiff penalty if you’re audited.
The money you pay for employees’ salaries, as well as the costs of their benefits, can be deducted. But it’s not always the case. Here are some of the requirements to make sure the expenses of compensation qualify for deductions:
- The employee provided the services they were compensated for
- The employee isn’t in any way an owner of the business
- The employee’s salary meets the qualifications of “reasonable” and “necessary”
Do you use a phone for your business? The internet, perhaps? Congratulations, because if you do, then you’re officially part of the modern world. In other news, you can also deduct the expenses as long as they are related to business needs. If you’re also using the phone and internet for personal needs, you’ll need to itemize the use and only deduct the related percentage of the costs.
Running a business often requires you to get from point A to point B. Those travel expenses can be deductible, but the IRS has obviously added stipulations to make sure that it’s all legitimate. You can’t just take a jaunt with your buddies to Vegas and then claim it was all for business.
In order for your travel expenses to qualify for deductions, they must fall within the normal bounds of “ordinary” and “necessary.” They also need to have been incurred away from your tax home, which is where you conduct your business. Also, the expenses must come from a trip that was more intense than just a regular day.
Examples of qualified expenses include:
- Airline tickets
- Train tickets
- Bus tickets
- Shipping business materials
Of course, you’ll need to keep detailed records. Make sure to note the location of your trip, how it related to your business, and how long you were there.
The best entrepreneurs are committed to getting better. So if you complete a development course or some other form of professional education that enhances your abilities within your industry, you can deduct the related costs.
There Are Also Credits to Consider
While this guide has focused on deductions, tax credits are another crucial way that your business can save money. Tax credits are offered by the IRS to encourage businesses to take certain actions that meet the agency’s objectives. It’s a reward for mutually beneficial actions.
There are a couple of primary differences between deductions and credits:
- Timing: Deductions are handled prior to calculating your taxes, which lowers your tax bill. Credits come after you’ve finished your calculations and are subtracted from the total amount you owe.
- Form: Deductions are applied as percentages. But credits are dollar-for-dollar reductions, so if you earn a $1,000 tax credit, you’ll have $1,000 taken off your tax bill.
If you’re ready to learn more about credits, here are 23 federal tax credits that you should consider looking into. You won’t qualify for all of them, but there might be a few that can save you money next tax season.
- General Business Credit (Form 3800)
- Investment Credit (Form 3468)
- Work Opportunity Credit (Form 5884)
- Credit for Increasing Research Activities (Form 6765)
- Low-Income Housing Credit (Form 8586)
- Recapture of Low-Income Housing Credit (Form 8611)
- Disabled Access Credit (Form 8826)
- Qualified Plug-in Electric and Electric Vehicle Credit (Form 8834)
- Renewable Electricity, Refined Coal, and Indian Coal Production Credit (Form 8835)
- Empowerment Zone and Renewal Community Employment Credit (Form 8844)
- Indian Employment Credit (Form 8845)
- Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips (Form 8846)
- Credit for Contributions to Selected Community Development Corporations (Form 8847)
- Biodiesel and Renewable Diesel Fuels Credit (Form 8864)
- New Markets Credit (Form 8874)
- Credit for Small Employer Pension Plan Startup Costs (Form 8881)
- Credit for Employer-Provided Childcare Facilities and Services (Form 8882)
- Low Sulfur Diesel Fuel Production Credit (Form 8896)
- Qualified Railroad Track Maintenance Credit (Form 8900)
- Distilled Spirits Credit (Form 8906)
- Energy Efficient Home Credit (Form 8908)
- Alternative Motor Vehicle Credit (Form 8910)
- Alternative Fuel Vehicle Refueling Property Credit (Form 8911)
Another credit to think about is the Earned Income Tax Credit (EITC). If you have filed a Form 1040 Schedule C, you might be able to qualify for this substantial credit for entrepreneurs.
Remember, qualifying for a tax credit requires an action on your part. So you’ll need to confirm that it’s worth the effort.
“All tax credits come with restrictions and qualifications that you must meet,” says small business tax guru Jean Murray. “You can’t apply for a tax credit until you have spent money on the purchase or the activity, so get help from your tax professional before you make this commitment.”
To dive deeper into the wonderful world of tax credits, click here for additional details from the IRS regarding qualification and submission. The IRS has prepared the EITC Assistant to help you learn more and see if you are able to take advantage of it.
By using both deductions and credits in your tax strategy, you can bring diverse benefits to your business and save a lot of money on your tax bill. It takes effort to do the research and confirm compliance, but the rewards clearly make it all worthwhile.