Which Small Business Expenses are Eligible for Tax Deductions?
When operating a small business, tax breaks can be the difference between a loss, breaking even and making a profit. This is especially true in the earliest years when entrepreneurs are still paying off the initial investments and startup costs. The first step in deciding what tax deductions your business may be eligible for is identifying your business expenses. You must also separate your business from your personal expenses. Note that business expenses are the costs associated with running the company, such as payroll, and may be deductible if it is operated with the intention of generating a profit.
Some expenses may be fully deductible while other costs are only partially deductible. In general, you may be able to subtract the entire amount of a fully deductible expenditure from your gross income. A partially deductible expense, however, may be limited to a percentage of the total spent or capped at a fixed amount.
According to the IRS, for a business expense to be tax deductible, it must be both necessary and ordinary. A necessary business expense is one that makes running the business possible. However, it does not need to be indispensable or mandatory to be considered necessary for tax purposes. An ordinary expense is one that is fairly common or appropriate in your industry.
Business Loan Interest
If you used a business loan to start your company, then you may be able to claim the interest as a tax-deductible expense. There are some requirements that need to be met to pull this off. For starters, the business must be legally liable for the loan. There must also be an agreement that you intend to pay off the loan, and there must be a legitimate debtor-creditor relationship. In other words, it may be difficult to justify writing off interest on a startup loan from a friend or family member.
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Business Use of Your Car
If your business involves a lot of driving around town to provide services or deliver goods, then you may be able to deduct car expenses, such as insurance premiums or car payments. However, if you use your car for both business and personal reasons, you need to first calculate the mileage spent on business. For 2019, you can deduct 58 cents per mile for business, 14 cents per mile for charity and 20 cents per mile for medical moving.
These are the highest deductions for business use of cars since the economic recession in 2008. There are also depreciation allowances on vehicles used for businesses. Some of the professionals who will benefit most from these deductions include cab drivers, truck drivers and traveling salespeople.
Business Use of Your Home
If you have an office at home, such as in the garage, attic, basement or even a separate structure on your property, you may take deductions for business use of your home. The deductible expenses include repairs, utilities, insurance, rent and mortgage interest. However, this depends on how you choose to calculate the deduction.
The simplified option and regular method are the two available techniques. When using the simplified option, business owners use a rate of $5 per square foot of home used for business up to 300 square feet. For the regular method, business owners calculate the actual cost of the home office as a percentage of the overall costs associated with owning or renting and maintaining the home.
For a home office to qualify for the deduction, it must also meet some important requirements. The office space must be used exclusively for business on a regular basis. It should also be your principal place of business. This does not mean it has to be primarily where business takes place, but it must be a location where substantial business operations occur, such as manufacturing products, meeting with clients or completing projects.
Not all costs can be deducted. Depending on the size of your small business, some expenses may need to be capitalized. When expenses are capitalized, they are considered an investment in your business rather than a liability. In other words, they are assets. See some examples of this below:
- Office supplies
- Business startup costs
- Furniture and equipment
- Renovations and office improvements
Some business startup costs can be amortized instead of deducted. This may help entrepreneurs to recover some of the money they spend on getting their business up and running.
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Believe it or not, some taxes qualify as deductible expenses. These taxes must be directly related to business operations. Local, state and federal taxes that meet this criterion may qualify. Some foreign taxes may also be eligible.
Corporate Dinners and Lodgings
Unfortunately, business owners may no longer write off expenses related to entertainment, amusement or recreation. However, you may still write off up to 50% of meals as long as you don’t go splurging at an expensive restaurant to impress the client.
The cost of traveling to the location may be deductible under business use of a car. If you traveled by plane to the location, the flight may be tax deductible unless you used frequent flyer miles. Note also that not all hotel expenses are deductible. The cost of bringing family and friends, who do not work for the business, along for the trip are not tax deductible either.
Cost of Goods Sold
Whether you manufacture products, sell products, provide a service or a combination of these, the operations costs related to this are eligible for a tax deduction. Accountants deduct the cost of goods sold from gross revenue to arrive at the gross profits for the year. However, once you include an expense in this section, it cannot be deducted again as a business expense.
Here are some of the most common types of expenses in this category:
- Overhead for the building
- Cost of raw materials or ingredients
- Payroll for workers who create the products or provide the services
When it comes to payroll expenses, more than just wages or salaries may be deductible. Businesses can also take tax deductions for holiday bonuses, retirement savings plans and even health insurance. Be sure to confirm with your accountant which of these expenses may be full or partial deductions.
Payroll does not always cover all labor costs. Small and large businesses alike may seek to reduce costs by hiring freelancers, independent contractors or companies that act as vendors. Payments to these individuals or corporations may also be tax deductible.
Some businesses must maintain expensive insurance coverage for legal purposes. Others may maintain it due to the high cost of claims in their industry. Some companies with high insurance premiums may include medical practitioners and construction companies. Thankfully, these insurance costs are deductible as long as you can prove that they are related to your business or profession.
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According to Forbes, a quarter of new businesses in America are created by immigrants. One of the hassles that can come with this is maintaining eligibility to remain in the United States. Immigration fees can run into the thousands over a few years to pay for work permits, conditional green cards, permanent green cards, extensions, biometrics and naturalization.
When an immigrant has moved their entire family with them, then the costs are even higher. Because of this, many immigrants may wish to deduct the cost of their immigration fees. Unfortunately, immigration fees are not typically a deductible expense.
For business owners who enter the country via an investor visa, they may be able to claim some of the investment as a business expense. Nevertheless, it may be wise to speak with an accountant and an immigration professional to decide whether or not it is wise to do so.
When running a business, owners may sometimes attempt to reduce operating costs and boost profit to ensure financial success. While there is no real flaw in this logic, reinvesting profits in the business may also reward the business twofold. This occurs not just through the investment itself, but by the fact that the investment may be reclaimed through tax deductions in the following year. Nevertheless, this is just a simplified account of how taxes and tax deductions work. To avoid running afoul of the IRS and local tax agencies, it is best to employ the help of a professional.