One of the perks of having your own small business is that you can deduct legitimate business expenses from your business’s taxable income. That means the U.S. government underwrites a good chunk of your costs. Cool, right?
In order to be deductible, Uncle Sam requires that those expenses be “ordinary and necessary.” As long as they fit that definition, you can take advantage of the tax benefits.
Let’s review some of the most important small business tax deductions and clarify how you can put them to best use.
Any costs you incur that are required to keep your business operating are deductible.That includes things like utilities, supplies, rent, software subscriptions, etc. This also includes the amounts you spent on professionals such CPAs and lawyers.
Your taxable income is reduced by these costs in the year you paid those bills. Generally, if you bought good or services that will be used within a year, you can deduct them as operating expenses.
If you buy equipment, property or other assets that will likely serve you for a year or longer, you usually write these costs off over the course of many years. Some assets qualify for what’s called a ‘179 deduction.’ That means you may be able to deduct the full amount of your costs for something that is really a long-term asset in the year you buy it.
Depending on the type of asset, you either amortize or depreciate it. This can be complicated. But it also opens up the opportunity for planning to help you minimize your tax expense. For these reasons, it’s best to consult a tax pro on capitalized costs.
Home office deductions
Small business owners get some tax benefits if they work out of their home. Those benefits include deductions on a proportional amount of mortgage interest, insurance, utilities, depreciation, etc.
In other words, if the space you use for work takes up 15% of your home, you get to claim 15% of those costs for your business. However, to claim this, you have to use that space exclusively and regularly for your business. That means you can’t use this space for anything else but business.
To claim this goodie, you can either fill out a rather complicated form 8829 or you can use Schedule C. The latter is very simple to use but it limits you to a maximum $1,500 deduction.
Again, I suggest that you speak with a tax pro before writing off your home office. Some tax professionals say this is a red flag for the IRS and can trigger an audit. Others say it isn’t. But when it comes to the IRS, I always suggest you err on the side of caution.
Wages for kids
One of the best perks of owning your own company is that you decide who you can hire. And if you hire your kids (and they really do work for you) there are tax benefits aplenty.
First of all, chances are good that your kids are in a much lower tax bracket than you are. That means they might get away with paying low to even no taxes while you get a full deduction.
Does it get any better than that?!
If you use a car, SUV or pickup truck for business, you can probably write off a good part of your costs.
One type of deductible cost is depreciation, but that doesn’t mean you can buy yourself a Lamborghini and get the government to give you a tax break! The depreciation write-off for business-use vehicles is limited to prevent people from buying luxury cars and getting a tax benefit.
In addition to depreciation, you can write off your actual costs or take a standard mileage deduction. If you have a low-cost auto, the standard deduction is probably the best way to go. If it costs you an arm and a leg to run your jalopy for work, use that actual cost.
In 2017, the standard mileage deduction is 53.5 cents per business mile driven – down from 54 cents in 2016. If you take the standard mileage deduction, just make sure to keep track of the total miles driven and the total miles driven for business and retain those records in case the IRS wants a closer look.
Remember that business miles include visiting clients, business professionals such your CPA and attorney, going to the bank and picking up business supplies.
Sadly, the miles you drive from your home to your work are not deductible. The meter starts ticking when you leave for your first business appointment outside of the office and ends when you finish your last appointment. However, if you work out of your home, you can start deducting miles from the minute you leave your home.
If you decide to deduct your actual expenses, you can include fuel, repairs, tires, registration, taxes, insurance and depreciation – almost everything.
If you use your vehicle for work, make sure to keep excellent records. The IRS can make your life very difficult if they decide to audit you and you don’t have the paperwork to back your deductions up.
The type of business entity you have impacts the way you claim this deduction. For example, if you are a sole proprietor, you can use either the actual cost method or the standard mileage deduction.
If you have an S or C Corporation and you own the car individually, the company can reimburse you using the standard mileage deduction. If the company does not reimburse you as an employee, you can use either method and take the deduction on your personal return.
If your corporation owns the car, the company uses actual operating expenses for the tax return. And if the car is used by the employee (you) for personal use, the corporation can still write off all the expenses of the vehicle so long as the employee treats the personal use of the vehicle as a taxable benefit.
Travel expenses can be deductible but only under certain conditions. Specifically, you need to be away from the general area of your employment (your tax home) in order to do your job to write those costs off. Keep in mind that this works as long as being away is temporary. If you’ve been permanently re-assigned, you can’t take the deduction.
Assuming your travel expenses meet the requirements, there is a long list of items you can deduct from income:
- Airplane, train, bus or car costs to get from home to the business location
- Shipping costs
- 50% of your meals and 100% of your hotels – including tips
- Laundry and dry cleaning
- Anything else that you incurred that was necessary to do your business while away
Keep in mind that even if you take some personal time while you are away, you can still deduct the cost to travel to that destination as long as the main reason you went was for business. If your main goal was personal but you did a little business while you were away, you can only deduct those costs which were directly related to your business – and that does not include your plane, train, bus or car fare.
If a customer doesn’t pay their bill for physical goods you sold them, you may be able to write off that loss depending on the accounting method you use to recognize income. If you only recognize sales when you receive money — aka the cash basis approach — you can’t write off bad debts. However, if you report when the sale is made — aka the accrual method — you can write off any amounts that you don’t actually collect.
In both cases, as long as goods are involved, you can deduct your costs for those products. But regardless of your accounting method, if you sell services, you are out of luck. If you don’t have out-of-pocket costs, you can’t get a tax deduction.
Health care costs
This is another area where the tax treatment depends on the kind of entity you have.
If you run a sole proprietorship, you can write off all health care insurance payments as long as the total isn’t greater than the net profit of the company. The only caveat is that if you or spouse qualify for other health insurance coverage (for example, through your spouse’s employer,) then you can’t take the deduction for your plan even if you don’t take that other coverage.
The good news is that if your spouse worked for your company, you can also use those premiums as a full deduction. Just make sure to play it straight. If your spouse didn’t really work for you, then the IRS can audit you, fine you and prosecute you. Avoid that by not being too creative when it comes to your tax return.
If you operate the business in any form other than a sole proprietorship, my suggestion is to speak with your CPA. It’s complicated!
Contribution limits for self-employed retirement plans are much higher than the limits imposed on the normal IRA.
For example, if you open a SEP, you can sock away the lesser of 25% of your compensation or $53,000 ($54,000 for 2017).
This is one of the key perks of owning your own business and the best advice for most business owners is to max out retirement contributions whenever possible.
As you can see, owning your own small business brings with it many opportunities to reduce your tax liability. However, the IRS is very good at policing the regulations. On the one hand, you don’t want to miss these opportunities. On the other hand, you don’t want to misapply the rules and end up in hot water. For that reason, it’s usually smart to pay a small amount to a tax professional just to make sure you stay on the straight and narrow.