When you're running a small business, the bills can add up quickly. Fortunately, the government helps entrepreneurs by offering a wide range of business expense deductions so you keep more of your profits. If you're wondering what might qualify for a tax break, here are a few items that may count as small business tax deductions.
What Counts as Tax Deductible?
For an expense to be tax deductible, the Internal Revenue Service (IRS) states that it must be both ordinary and necessary for your small business. Ordinary means the expense is common for your industry. For example, buying a tractor for a farm may be considered an ordinary expense but would likely be harder to justify for a bakery.
Necessary means the expense helps run your business more effectively. For instance, renting out a storefront could count as a necessary expense but buying expensive designer curtains for your office might not be justifiable. Understanding the general IRS guidelines can help you identify possible small business tax deductions.
Bear in mind that these IRS rules and deductions apply specifically to federal taxes. Your state and local tax agencies may have their own deductions and qualifications, which may include or exclude those offered on a federal level.
What Are Possible Small Business Tax Deductions?
A wide range of expenses can meet the IRS definition for what counts as deductible. Some common, possible tax deductions for your business might include:
- Salaries paid to your employees
- The cost of renting a building or storefront along with the utilities
- Office supplies
- Your business startup costs, such as expenses associated with researching your market, visiting potential spots to locate your business, and training employees
- Marketing and advertising costs
- Fees for a lawyer, accountant or other professional business advisor
- Travel expenses to see clients
- Contributions into a retirement plan for yourself or employees
- Interest you pay on a business debt
The IRS has also provided a complete list of possible business expense deductions within the "Tax Guide for Small Businesses."
Tracking Personal vs. Business Expenses
Some expenses are split between personal and business use. For example, maybe you use a company car both at home and for work. To claim your business tax deduction, you'll likely need to track what percentage of the use is for your small business.
So in the case of a car, you would record your mileage during the year to see how many miles you drove personally versus for work. You can only deduct the percentage of vehicle expenses for business use. If you drove half the time for work, then you could deduct half the cost of your gas, maintenance, car lease payments, etc. The IRS may ask to see relevant documentation for you to claim your business expense deductions, so it will likely help to keep clear records. Consulting with a tax advisor can help you better understand what documentation to hold onto and other considerations.
What Is Cost of Goods Sold?
If your business sells products, you may not owe taxes on the entire sale. The IRS only taxes your profit above what it cost to create the product. To figure out your gross profit, you can generally take your total receipts and subtract the cost of goods sold. This typically includes what you originally paid for the product or materials, along with any labor costs to produce your goods, storage and overhead. This generally gets you to your gross profit, which is then taxable.
The IRS asks you to do this calculation first to get your gross profit, and then claim the tax deductions against your gross profit.
What Are Capital Expenses?
Capital expenses can be a more confusing tax subject. These are when you buy property that your small business will use for more than one year — such as buildings, vehicles, equipment and furniture. You may not be able to deduct these purchases immediately as a small business deduction. Instead, you'll need to capitalize the expense.
What this means is that you spread the cost over the expected life of the property and claim a portion of the deduction each year. For example, the IRS states that a company car has an expected life of five years, so you can only deduct 20% of the purchase each year.
This information is just a general overview of small business tax deductions and should not be used as guide to prepare your actual return. If you have any questions about what could be deductible for your business startup costs and beyond, consider meeting with a tax advisor.