From the budding entrepreneur to an established business owner, it is always a good idea to review available business deductions and ensure you’re maximizing your return come tax season.
Tax deduction rules change—in fact, the IRS has expanded several business and personal tax deductions due to the COVID-19 pandemic alone. And you might be surprised to learn what business expenses you can write off that you have never considered before.
We’ve put together this quick guide to business tax deductions to educate new owners and provide a refresher to the veterans. Keep reading to learn:
What a tax deduction is;
What business expenses are deductible (plus explanations of cost of goods sold, capital expenses, and separation of business vs. personal expenses);
15 common small business tax deductions; and
Personal tax benefits small business owners should know.
What is a Tax Deduction?
Also known as a tax write-off, a deduction is an expense you can deduct from your taxable income. You do this simply by subtracting the amount of the expense from your taxable income.
What Business Expenses are Deductible?
A deductible business expense must be both ordinary and necessary. The IRS defines:
An ordinary expense as one that is common and accepted in your trade or business.
A necessary expense as one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.
Write-offs must fit the IRS criteria, so it’s important to know the types of business tax deductions available to ensure you are compliant and maximize your deductions. By identifying all deductible costs, you can reduce the income you need to pay taxes on (i.e., your tax liability).
The IRS states that you must separate business expenses from:
Expenses used to figure the cost of goods sold,
Capital expenses, and
Personal expenses.
But what, exactly, are those expenses? And what do you do with them?
Cost of Goods Sold
A business that manufactures products or purchases them for resale usually must take inventory at the beginning and end of each tax year to determine their cost of goods sold (COGS). Small business taxpayers (defined below) are the exception to this.
You may use some costs to calculate your COGS, which is deducted from your gross receipts to determine your gross annual profit. Note that once you include an expense in the COGS, you can’t write it off as a business expense.
What is a Small Business Taxpayer?
A small business taxpayer must:
Have average annual gross receipts of $25 million or less for the last three tax years, and
Not be a tax shelter.
Capital Expenses
Some costs are part of your investment in your business that you will need to capitalize instead of deducting. These capital expenses are considered business assets. The three general types of capital expenses are:
Business start-up costs (e.g., business licenses and legal costs)
Business assets (e.g., computers, equipment, furniture, and fixtures)
Improvements (e.g., office and building renovations)
You will need to depreciate these assets over several years because you will use them for more than one year. Depreciation, another essential business tax deduction, helps reduce your tax liability because you subtract the depreciation amount from your taxable income.
Pro Tip: Keep a list of your assets and update at least annually. Ideally, you should establish an internal policy for assessing purchases as capital assets.
Personal vs. Business Expenses
Typically, a business owner can’t write off personal, living, or family expenses, but you may pay for something used partly for business and partly for personal purposes. In this case, you can divide the total cost between business and personal use and deduct the business part.
For example, you might use part of your home for business, meaning you may be able to deduct mortgage interest, insurance, utilities, repairs, and depreciation. You may also use your car for business purposes, in which case you could divide your expenses based on mileage. There are also apps such as MileIQ that make tracking business mileage very easy.
Check out our other blog post for more tips on separating personal and business finances.
15 Common Small Business Tax Deductions
Below is a list of 15 business tax deduction categories typically available to sole proprietors, partnerships, and LLCs.
Advertising and Promotion: These include marketing expenses like hiring designers to redesign your company logo or website.
Business Meals: Normally, you can deduct 50% of qualifying food and beverage costs, but due to the COVID-19 pandemic, the government is allowing businesses to deduct 100% of business meals and beverages purchased from restaurants for 2021 and 2022.
Business Insurance: You can deduct premiums you pay for business insurance, such as property coverage, liability insurance, and workers’ compensation.
Business Interest and Bank Fees: These include business loan and credit card interest as well as monthly service charges, overdraft fees, and transaction fees paid to third-party processors.
Business Vehicle Use: If you use a car entirely for business purposes, you can deduct the total cost of the vehicle. If you use it both personally and professionally, you can only deduct expenses associated with business usage.
Contract Labor: If you hire freelancers or contractors for your business, you can deduct their fees as a business expense.
Education: You can deduct education costs that add value to your business and boost your expertise (e.g., classes, seminars, professional books and publications, workshops, and transportation to and from classes).
Home Office: If you operate a business out of your home, you may be able to deduct a portion of your housing expenses against your taxable income.
Legal and Professional Fees: Costs associated with operating your business, such as fees from lawyers, accountants, bookkeepers, and CPAs, are deductible.
Moving Expenses: Businesses can deduct the costs of moving business equipment, supplies, and inventory from one business location to another. Just be sure to keep clear records of these expenses.
Rent Expenses: You can deduct the costs of renting a location or equipment for your business.
Salaries and Benefits: Employee salaries, benefits, and vacation time are generally deductible.
Taxes and Licenses: You can deduct business licenses and taxes such as state income and payroll taxes from your taxable income.
Telephone and Internet Expenses: If phone and internet are critical to your business, you can also deduct them. If you use them for personal and business purposes, you can only deduct the percentage allocated to business usage.
Travel Expenses: You can deduct a business trip that is ordinary, necessary, and away from your tax home (i.e., the city or area in which you conduct business).
Pro Tip: Track your meals, entertainment, and travel expenses separately to maximize your tax deductions!
Personal Tax Benefits Small Business Owners Should Know
You’re likely prepping both business and personal taxes simultaneously, so you should be aware of personal tax deductions that small business owners can claim on their individual tax returns.
Earned Income Tax Credit
Those who earn a low to moderate income may qualify for the Earned Income Tax Credit (EITC) to reduce their tax burden. You must meet certain requirements and file a tax return to be eligible—even if you do not owe any taxes or are not required to file. You may receive a refund if the EITC reduces your tax liability to less than zero.
The U.S. government states that if you earned less in 2020 than you did in 2019, you can use your 2019 income to calculate your EITC.
Advance Child Tax Credit
You can claim the Child Tax Credit (CTC) to reduce the amount you owe on your personal tax return. This is calculated based on your income and the number of qualifying children you are claiming.
Even those who do not pay taxes may still qualify for the CTC.
The CTC was expanded under American Rescue Plan Act (ARPA) for the 2021 tax year. Eligible individuals started receiving CTC payments on July 15, which will continue through December 2021. Under ARPA, families are eligible to receive:
Up to $3,000 per qualifying child between ages 6 and 17, and
Up to $3,600 per qualifying child under age 6.
The IRS started sending letters in early June to 36 million families who might qualify for the monthly payments. Most families do not need to do anything to receive their payments, as long as they’ve filed their 2020 or 2019 tax return.
Visit the Child Tax Credit Update Portal to ensure your information is up-to-date.
Energy Tax Incentives
You can receive tax credits for energy-efficient appliances and for making energy-saving improvements to your home and business (e.g., solar panels). These include local, utility, state, and federal incentives.
Find out if you qualify for energy-related incentives by searching the Database of State Incentives for Renewables and Efficiency (DSIRE) or finding out if your state offers a sales tax holiday on energy-efficient home appliances.
Charitable Donations
Although sole proprietorships, LLCs, and partnerships can’t deduct charitable donations as a business expense, you may write it off on your personal tax return as long as you made it to a 501(c)3 organization.
With the proper documentation, you can claim charitable vehicle or cash donations by filing a Schedule A with your tax form. To deduct a non-cash contribution, you’ll need to file Form 8283.
Remember, the key to maximizing your business tax deductions is by keeping detailed, organized records year-round. That’s why many owners enlist the help of an accountant and tax professional to ensure their expenses are tracked accurately. If you are exploring options to outsource your accounting, schedule a complimentary consultation with us today or call us at 603-505-2368 to find out how we can help your organization increase your bottom line!