Did you know that not all small business expenses are created equal when it comes to your annual tax return? Most entrepreneurs understand that deductible expenses help to offset many of the costs of running a business. But not every expenditure is fully tax deductible. Understanding which expenses can effectively reduce your taxable income will not only help you estimate your tax obligation for the coming year, it will improve your business planning.
What is a Deductible Business Expense?
Allowable small business expenses look different depending on whether your company is a sole proprietorship, a corporation, a partnership, or an LLC (Limited Liability Company). Eligible expenses also tend to change from time to time, as government tax regulations evolve.
Before you bank on certain costs being deductible come tax time, it’s important that you consult with the IRS or your accounting professional to confirm the eligibility of various small business expenses - and any limits or timing issues that may affect them.
Remember, the IRS defines a small business expense as any cost associated with carrying on your trade. But to be considered deductible, those expenses must be both “ordinary and necessary” - and you must be in business to earn a profit.
Ordinary expenses include any that are common and accepted in your particular industry. They do NOT, however, include:
- personal expenses (those associated with non-business-related activities or property),
- capital expenses (business assets and expenses considered to be investments in, or improvements to, your business), or
- expenses used to calculate your Cost of Goods Sold (COGS expenses include the cost of products destined for resale, the raw materials and labor costs associated with manufacturing saleable goods, and the freight and storage of either of these)
Necessary expenses, meanwhile, are any deemed both helpful and appropriate when it comes to generating income for your business.
Tax-Deductible Expenses You Should Know About
Some business expenses (like meals) are only partially tax deductible - or only become eligible as deductions under certain circumstances, or when specific criteria are met. So here’s a handy reference list of some common small businesses expenses that were considered fully tax deductible - in most cases - in the recent tax year:
Business Location-Related Expenses
- Consumable items like office supplies (printer paper, for example) and postage, office expenses like internet services, and items like cleaning supplies.
- Utilities such as electricity for your business space.
- The rent you pay for your office, storefront, studio, restaurant, or factory.
- The mortgage interest and property taxes on real estate owned by your business.
- Business insurance premiums and other policy costs associated with coverages like general liability, malpractice, business continuation, and cyber security.
- Ordinary maintenance and repairs to your business space (does not include major renovations or overhauls).
- The fees you pay to lease or rent business machinery or equipment.
- Payments you make to employees, such as salaries, wages, commissions and fees, bonuses, gifts, and awards.
- Payroll and other employer taxes, which typically include your share of FICA (Social Security and Medicare) tax amounts, and state or federal unemployment insurance contributions.
- Employee benefit programs like qualified health plans, life insurance, dependent care assistance, and education assistance.
- Transportation costs like airfare and lodging when you or your employees must travel out of town for business.
- You can also deduct the cost of using independent contractors or freelancers to supplement your labor requirements.
- Ordinary advertising costs.
- Legal and accounting fees.
- Membership dues for business-related organizations.
- Business licenses and business franchise taxes.
- Business vehicle registration taxes.
- The interest you pay on business loans or lines of credit is also fully deductible most of the time.
In every one of these cases, it’s advisable that you discuss your individual situation with a tax advisor to make sure you’ve done everything necessary to qualify for a specific deduction.
Tax Deductions vs Tax Credits: What’s the Difference?
The main difference between business tax deductions and tax credits is that credits directly reduce the amount of tax your business owes, while deductions may lower that amount indirectly by decreasing your taxable income.
Whether your company bills for fees, sells a product, charges interest, or leases equipment or property, your taxable income in any given year is loosely arrived at by subtracting allowable business deductions from your gross sales. So while deductions like small business expenses may not seem as rewarding as tax credits on the surface, they can still have a significant impact on your bank account – especially if your revenues are healthy.
The bottom line is that tax deductions, exemptions, and credits all work together to keep your tax liability as minimal as possible. And the best way to take advantage of all the tax-reducing benefits available to your business is by working with a qualified bookkeeping or accounting professional.
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