When it comes to taxes, it’s not the revenue you take in, but the amount left over after deducting certain expenses that determines your tax profits.
Most business costs are deductible, although there may be limits on the amount that can be written off or the timing for claiming the deduction.
Overview: What are the business-related tax deductions?
There’s a general rule in tax law that allows you to deduct “ordinary and necessary” business expenses. An expense is “ordinary” if it’s common and accepted in your trade or business. An expense is “necessary” if it’s helpful and appropriate to your trade or business.
It doesn’t have to be indispensable to be considered necessary. Many types of business expenses are specifically addressed on the tax return, with a line to enter the deductible amount. Others may be listed separately by you.
The following discussion covers various deductions related to aspects of your business, but keep in mind that some costs are not deductible.
1. Capital expenditures
As the term implies, they must be “capitalized,” which means they’re recorded as an asset on the balance sheet and may not be immediately deductible. For example, if your business buys a building, the cost of the building is capitalized.
For tax purposes, a capital expenditure has a basis, which is the amount that can be written off. Basis is usually the cost of the capital asset, with certain adjustments. For example, attorney’s fees related to the purchase are added to the basis of the building.
Many capital expenditures can be deducted through depreciation (such as the cost of a commercial building, but not the land, over a 39-year period) or other special allowances (explained later under “equipment”). Details on depreciation are in IRS Publication 946.
2. Cost of goods sold
This is not a separate deduction; it’s factored into reporting revenue from the sale of inventory. In general terms, instead of separately deducting the cost of your inventory items (essentially the cost of goods sold), you reduce your gross receipts from the sale of inventory items so that your income is modified accordingly.
However, small businesses that sell goods may not have to maintain inventory and instead can account for items as materials and supplies (explained later).
3. Costs that qualify for a tax credit
Certain expenditures may entitle you to a tax credit rather than a deduction. A credit is a dollar-for-dollar reduction of your tax bill. For example, if your small business pays a certain amount of health insurance premiums for your staff, and other conditions are met, you may qualify for a tax credit of 50% of your premium payments.
4. Personal expenses
Personal expenses are not deductible. For example, the cost of your commuting to the office is a personal expense that can’t be deducted.
5. Business expenses that the tax law specifically bars
This includes entertainment costs even if they are incurred solely for business purposes.
The qualified business income (QBI) deduction, which is a write-off for owners of pass-through entities, is not deducted as a business expense; it’s a personal deduction based on business income.
Small business tax deductions related to your staff
If you have any employees, including yourself, there are several deductions available to you. Following are the major ones to consider.
Taxable compensation includes wages, salary, commissions, and bonuses. It also includes certain taxable fringe benefits, such as reimbursement for moving expenses. Taxable fringe benefits are deductible as taxable compensation.
2. Employment taxes
These include the employer share of Social Security and Medicare (FICA) taxes, federal unemployment tax (FUTA), and state unemployment tax.
3. Fringe benefits
Employers may offer employees more than just a paycheck. They may pay for various fringe benefits (also called perks) that employees can enjoy on a tax-free basis. Employers can usually deduct the cost of fringe benefits and may not owe any employment taxes on them. Some examples of fringe benefits are:
- Medical coverage: This may be premiums paid by the company or certain reimbursements to employees under specific types of health reimbursement arrangements (e.g., qualified small employer health reimbursement arrangement or individual coverage health reimbursement arrangement).
- Retirement plans: Employer contributions to qualified retirement plans for the benefit of employees who participate are deductible. Annual limits on contributions apply, and you may be eligible for a tax credit for starting up a plan.
- Other fringe benefits: Even though many of these benefits are tax-free for employees, you pay for them and can deduct them. Learn more in IRS Publication 15-B.
Small business tax deductions related to your vehicles and equipment
Whether you own or lease a vehicle, you can deduct the actual costs of driving it for business -- gas, repairs, etc. (with certain limits) -- or use an IRS-set standard mileage rate (58 cents per mile in 2019; 57.5 cents per mile in 2020).
Any item with a useful life of more than a year generally must be depreciated, which means the cost is written off over the recovery period fixed by law. However, the entire cost can be deducted in the year the item is placed in service using a special tax rule outlined in the Section 179 deduction (below).
3. Section 179 deduction (“first-year expensing”)
This is a deduction up to a set dollar limit ($1,020,000 in 2019; $1,040,000 in 2020).
4. Bonus depreciation
Through 2022, you can deduct 100% of the cost of qualified property via a bonus depreciation. This includes tangible property (not real property or intangibles) with a recovery period of 20 years or less; off-the-shelf computer software; certain film, television, and live theatrical production costs; and certain plants bearing fruits and nuts.
5. De minimis rule
Instead of capitalizing the cost (listing the asset on your balance sheet), you can elect on your tax return to treat it as non-incidental materials and supplies. There are items for which you take a physical inventory or keep a record of consumption, in contrast to incidental items such as paper clips. This is available up to $2,500 per item or invoice (large businesses with special financial statements have a greater write-off limit).
Small business deductions related to your marketing
In promoting your business to increase sales and company visibility, you may incur a variety of costs, including the three below.
The cost of ordinary advertising is fully deductible, regardless of the media you use. So, if you advertise in your local newspaper or on Facebook, the cost is deductible. Advertising costs can also include business cards, brochures, and other materials. The IRS has yet to provide clear guidance on deducting costs associated with creating a website, but the costs for maintaining it are currently deductible.
The cost of treating customers and prospects to restaurant meals is deductible, as long as they aren’t lavish or extravagant (determined by the facts and circumstances of the situation). This could include taking a customer to breakfast or dinner. But only 50% of this legitimate business cost is deductible.
The costs of transportation, lodging, 50% of meals, and incidental expenses on the road are deductible. Local transportation costs, such as the Uber fare to visit a vendor, are also deductible.
Other important small business tax deductions
Circling back to the initial statement about ordinary and necessary business expenses, here’s a list of other common business costs you can deduct.
1. Attorney’s fees (that don’t have to be capitalized)
Examples include fees related to a contract dispute or for advice about an employment issue.
2. Bad debts
However, unpaid receivables cannot be deducted if you’re on the cash method of accounting; you’re simply out of pocket. (A different tax treatment applies to nonbusiness bad debts, which are bad debts that are not business bad debts.)
Most business owners likely have a policy to cover their property and liability to third parties. There are numerous other types of insurance -- business interruption, cyber liability, errors and omissions (malpractice), workers’ compensation -- that you may carry, and the costs for all of them are fully deductible.
For health insurance, special rules apply (part of the premiums may be a tax credit rather than a deduction; self-employed health insurance is not a business expense but rather a deductible personal expense).
4. Interest expense
The amount paid on money you borrow is deductible. (There’s a limit applicable to large businesses -- those with average annual gross receipts from the three prior years exceeding $26 million -- but small businesses are exempt). This includes interest on credit cards, lines of credit, and loans.
5. Licenses and permits
Check for annual renewal costs. There’s no cap on deducting this expense.
6. Maintenance and repairs
Ordinary maintenance and repair costs are fully deductible. However, expenditures that amount to capital improvements, such as a new roof, may not be immediately deductible.
The cost of the lease to your premises and lease payments for equipment are fully deductible.
8. Subscriptions and dues
Only dues to professional organizations, trade associations, and chambers of commerce are deductible; dues to country clubs, airline clubs, and the like, even if the memberships are for business purposes, are not deductible.
9. Taxes (but not federal income taxes).
There are a variety of taxes that are deductible, such as corporate income taxes (also referred to in some states as franchise taxes even though no franchise is involved), payroll taxes (the employer share of FICA, plus FUTA and state unemployment insurance that’s paid as a tax), and property taxes on any building or other real estate owned by the business.
Final words on small business tax deductions
Congress and the IRS are always tinkering with deductions, so stay alert to possible changes. To learn more, see IRS Publication 535, Business Expenses.
If you have any questions or concerns about writing off costs in your business, consult with a tax professional.
Alert: our top-rated cash back card now has 0% intro APR until 2025
This credit card is not just good – it’s so exceptional that our experts use it personally. It features a lengthy 0% intro APR period, a cash back rate of up to 5%, and all somehow for no annual fee!
Click here to read our full review for free and apply in just 2 minutes.
Our Research Expert
We're firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.
The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters.
Copyright © 2018 - 2024 The Ascent. All rights reserved.