You had a great idea and now you’ve put it in motion as a business. And while income recognition is easy to determine, qualified business deductions can be a bit harder. So… what are the most common tax deductions for small businesses?
Any materials you utilize for marketing your business and the cost of developing these can be deductible. This can be advertisements in print or media, brochures, branded promo items, events or trade shows. Non-branded gift cannot be deducted.
Business insurance is intended to protect your business as well as medical insurance that is paid by the business for its employees. Auto-related insurance falls under a different set of guidelines. A portion of your vehicle expense can be taken related to the business use of the vehicle, unless standard mileage is taken instead.
Depreciation and Section 179 expenses on capitalized business assets such as computers, office furniture, tools and equipment, and the like. Leasehold improvements and other real estate related capital expenses cannot be taken under Section 179. Special depreciation rules have been approved by the IRS in certain years that speed up depreciation life in qualified assets.
Home office deduction relates to the specific portion of your home that is utilized solely for business. This deduction is often misunderstood and abused. You must designate a space that is used exclusively and regularly for the trade or business. In general, this must be an actual office and not a convenient space in your home. More importantly, this space must only be used for business. To figure the deduction, you must take the costs associated with your home that relate to the space (rent, utilities, insurance, mortgage interest, real estate taxes, etc.) and then calculate the percentage of use of the home for the business.
Office supplies that you use and replace such as pens, paper, toner, hot/cold bags for deliveries, etc. Supplies that are used to create a product are considered Cost of Good Sold and are also deductible, as is the labor to create the product.
Travel related to business trips is deductible, such as airfare, lodging, rental cars and so on. If the trip has an element of personal costs or entertainment, these portions are not deductible.
If you travel for business, you can deduct the mileage driven to do your job at the IRS standard rate for the year. However, you cannot deduct the mileage for commuting to and from your job. If you leave your house and go directly to the client site, without stopping at the office first, you must still deduct the mileage that would have been considered commuting from your total miles. For example, if you went to a client site 14 miles away, but your normal commute to work would have been 4 miles, you can only deduct the 10 miles that are over and above your commuting miles.
Meals and entertainment have always been heavily scrutinized by the IRS. With the new tax law changes, very few deductions will be allowed for company-provided meals, and even less for employee-related entertainment and benefits. A good rule of thumb for currently meals that are deductible at 50%: client meal out and business discussion is the focus of the meal; travel meals; meals provided by the employer to the employee for the employer’s convenience; seminar/meeting meals; and office provided food/coffee. Meals that are 100% deductible are food provided to the public and certain office parties that are not extravagant in nature. And entertainment of a client with no business-related interaction is not deductible. Seeking the advice of a tax professional to determine which of your meals and entertainment qualify is advisable.
The costs of employees are also deductible including wages, employer portion of payroll taxes, employer-provided benefits, dues, and association costs, licensing, and retirement/pension plan employer costs.
Other less thought of deductions include: bank fees, education or training, library or industry-related subscriptions, commissions and fees, contract labor, janitorial, depletion, interest on loans or investments that utilized the funds for the business, legal and professional fees, rent or lease of a vehicle or equipment, repairs and maintenance, utilities, and taxes and licenses. Keep in mind that education costs must not be to qualify you for a new career. These fall outside of the realm of a business deduction. Also, starting in 2018, businesses with average annual gross receipts in the three prior years of more than $25 million are limited in the percentage of interest that’s deductible. Interest on loans by owners to buy their businesses are treated differently. Interest from an owner’s investment interest or passive activity interest is not a business deduction. Estimated, Federal or State taxes paid on behalf of the owner as reported on the personal returns are not deductible. Owner draws are not deductible to the business.
Business gifts are deductible, but only to a limited extent. The IRS allows for a deduction of only the first $25 worth of gifts to each customer. Meaning, that if you were to spend $100 on one customer, you would receive a deduction of $25. But if you were to spend that same $100 on four customers, you would be able to deduct $25 for each customer, or the full $100 spent.
Certain items are never deductible by the business. Some of these things are fines and penalties for breaking the law, life insurance premiums if the business is the beneficiary (directly or indirectly), and political donations. Unless it’s a required uniform you have to wear for work or protective clothing, you cannot deduct business clothing. Likewise, cellphone usage is limited by the amount of business use versus personal use. This must be well documented.
Charitable contributions made by the company are not deductible by the business itself unless it is a C Corporation. These will flow through to the owner’s personal return and be deducted on Schedule A if they itemize.
There are many different business deductions, each with their own unique qualifications. It is important to review these with your tax professional.