Key Takeaways
- Business tax deductions reduce the amount of tax you owe once you subtract certain expenses from your business income.
- As a small-business owner, just about any expense could be a business tax deduction.
- Keeping good records of your business expenses and receipts will give you an advantage at tax time to claim those business tax deductions.
- The qualified business income (QBI) tax deduction allows eligible self-employed individuals and small business owners of domestic pass-through entities to deduct 20% of their qualified net business income.
Whether you have an LLC, sole proprietorship, S-Corp, C-Corp or Partnership, tax deductions for small businesses can be very beneficial. However, filing business taxes can seem like an overwhelming task for a small business owner. Next to running a successful business, one of your major objectives each year is likely to receive the best possible outcome on your taxes. Staying organized and maintaining a plan is crucial for this to occur.
Your business has already earned the income and along the way you’ve encountered several expenses while operating your business. And now, during the tax season, you face figuring out how to reduce your tax bill. This can be accomplished by accounting for all your business expenditures, therefore maximizing your business tax deductions.
Just be sure not to confuse your personal finance expenses with your business expenses. The best advice is to check guidelines regularly on the IRS website since tax rules change frequently due to tax reform. Clean bookkeeping and expense tracking can help simplify this during tax time.
Remember an important thing when it comes to income and taxes: it’s not how much you make, it’s how much you keep. Keep detailed records of revenue and expenses to make filing easier.
How Do Business Tax Deductions Work?
Business tax deductions, sometimes referred to as tax write-offs, are expenses the business owner can deduct from taxable income to reduce their tax liability.
For example, suppose you own a lawn care company and you purchase a new riding lawnmower and order business cards. In that case, you can more than likely classify these expenses as a deduction, since they are ordinary and necessary for your business.
Business tax deductions decrease your overall profits. IRS Publication 535 discusses common business expenses and explains what is and is not tax deductible. Each small business is different, so soliciting tax guidance unique to your situation is advisable. When in doubt, contact a tax professional or CPA.
Things That Are Tax Deductible for Small Business Owners
Understanding what tax deductions are available to your business and taking advantage of those deductions gives you the ability to further reduce your taxable income and lessen the amount of your tax liability.
The best practice is to keep track of all your business expenses and hold on to your receipts so you will have the information needed to claim your business deductions during tax filing season.
There are several tax deductions that your small business can claim.
Business Meals
Generally, your business meals are 50% deductible as it pertains to the purchase of food or beverages associated with your operation. This also includes the meals provided when meeting with current or potential business customers, clients or consultants. Meal costs must be reasonable, not lavish or extravagant, or they could warrant unwanted attention from the IRS.
Current tax law allows a temporary 100% deduction of business meal expenses paid and or incurred after December 31, 2020, and before January 1, 2023, if a restaurant provides the meals. Be mindful that, while entertainment expenses are generally non-deductible, the cost of food and beverages purchased separately from the cost of the entertainment event is deductible.
Business Insurance
Business insurance premiums that your business pays are tax deductible. Since the IRS classifies business insurance as a necessary cost of conducting a trade or business, your policy premiums can be deducted from your income.
Common Types of Deductible Business Insurance Premiums
- General liability insurance that covers any legal expenses and damages arising from third-party injuries or property damages directly related to your business.
- Professional malpractice insurance that covers your personal liability for professional negligence that caused injury or damage to patients or clients.
- Business interruption insurance that pays for lost profits if your business is shut down due to a fire or other cause.
- Workers’ compensation insurance that covers any claims for job-related bodily injuries or illnesses suffered by employees in your business.
- Commercial property insurance that covers fires, storms, accidents and losses to your business property.
- Commercial auto insurance that covers vehicles used in your business for liability, damages and losses.
- Credit insurance that covers losses from certain business debts.
Advertising and Marketing
Costs spent on advertising and marketing to promote the business are tax deductible, but they must be ordinary and necessary according to the IRS. Expenses such as outdoor signs or banners, online internet and newsletter ads, radio announcements, meals and entertainment for the community and customized supplies with business logos are usually deductible.
Interest
Running a business might require additional funding at some point. You may take out a small business loan, open a business credit card or take out a business mortgage loan. The interest payments that you make on those loans can be claimed as a deduction.
Business Expenses
Just about any expense you have as a small business owner could be a tax deduction that can be written off against your business income. Maintaining and keeping accurate records of all your expenses plays a significant part in being able to claim those deductions at tax time.
Common business expenses include:
- Employee salaries and benefits
- Contract labor
- Phone and internet
- Employee and client gifts
- Legal fees
- Office supplies
Auto Expenses (Business Use of a Car)
If you use cars, SUVs or pickup trucks in your small business, you can deduct the business use of the vehicle. You can figure out your deduction amount by using one of two methods.
If you select the standard mileage rate method, you must own or lease the car and keep adequate records of your mileage, as the law requires. The deduction is calculated using the IRS’s standard mileage rate. Factored into the calculation is your total number of miles driven just for your business and the total number of miles driven during the year.
If you select the actual expenses method, you must determine the overall actual costs to operate the car of which a portion is business use. You should keep good records of all your expenses during the year. These expenses include repairs and maintenance, gas, oil, tires, rental or lease payments, insurance registration, licenses and depreciation. The deductible portion of these expenses is the percentage of use based on miles that the vehicle used for business.
Choose the method that gives you the highest deduction amount. If the operating costs of your vehicle are higher, then the actual cost method is more beneficial. However, if your vehicle is more economical to operate, then the standard mileage method will give you a larger deduction.
Depreciation
When you purchase equipment, machinery, furniture, buildings, software and vehicles for your trade or business, the IRS allows you to take annual depreciation tax deductions to recover the cost by depreciating the assets over a period of time.
- Bonus Depreciation
- Allows businesses to accelerate depreciation by deducting 100% of the cost of the asset in the year it was placed in service.
- De Minimis Safe Harbor Election
- You can elect to deduct up to $2,500 of small-dollar expenditures that may have required capitalization under previous tax rules.
- Section 179 Deduction
- Allows businesses to deduct the full cost of capital assets purchased for a trade or business and qualified real property.
Other Tax-Saving Options
Home Office Expenses
If you operate your business from your home, the IRS allows you to deduct the business use portion of certain home office expenses. To claim the home office deduction, you generally must exclusively and regularly use part of your home or a separate structure on your property as a primary place of business. There are two methods that you can choose from to determine your home office expense deduction.
- The Simplified Method
- You can deduct $5 per square foot of your home office used for qualified business use. As per IRS rules, the area of your home used to figure your deduction is limited to a maximum of 300 square feet.
Keep in mind that when electing the simplified method, you cannot deduct any actual expenses for the business except for business expenses not related to the use of the home or any depreciation for the portion of the home that is used for a qualified business.
- The Standard Method
- You can also deduct your actual expenses. A portion of your overall house expenses based on the area of your home used for qualified business use can be deducted. These expenses include utilities, exterminator or cleaning services, repairs, insurance, depreciation and security systems.
For example, if you use 10% of your home for business, you can deduct 10% of those expenses. Also, if an expense is only exclusive to your home office, such as installing new windows treatments for clients’ privacy, those expenses can be 100% deducted as home office expenses. You can claim home office depreciation to recover the cost of the business percentage use of the home through depreciation deductions.
Home Office Expense Deduction Options
Insurance
The cost of premiums paid for employee group medical insurance is deductible. Small businesses are typically able to deduct some of their health insurance-related expenses from their federal business taxes. Expenses that may qualify for these deductions include monthly premiums, contributions to an HSA and tax-advantaged dollars.
If you are self-employed and have a net profit for the year, you may deduct the amount you pay for medical, dental and qualifying long-term care insurance coverage for yourself, your spouse and your dependents as a self-employed health insurance deduction. This deduction will show as an adjustment to your gross income on Schedule 1 of Form 1040 and can be claimed regardless of if you choose the standard deduction or to itemize your deductions.
Life insurance premiums are also deductible as a business expense only when it covers your officers and employees, and the company is not the policy’s beneficiary.
Inventory
If your business manufactures goods or resells purchased items and products, then you keep inventory. The cost of the inventory or cost of goods sold (COGS) that your business directly paid for can be written off as a business tax deduction. To determine the cost of goods sold during the year, you must factor in your beginning and ending inventory balance.
Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory
Costs of goods sold includes costs directly related to producing your product such as purchases of raw materials or items for resale, factory labor, storage costs, purchase returns and allowances and freight-in costs. It doesn’t include indirect costs such as marketing costs, office expenses or overhead administrative salaries.
Legal and Professional Fees
In general, you can deduct legal and professional fees that are “ordinary and necessary” expenses paid for services related to running your business. This category does not include amounts paid to contractors or employees. These fees include those paid for professional services performed by consultants, accountants, bookkeepers, tax preparers and legal.
Office Rent/Overhead
As a small business, all typical overhead costs, such as rent, insurance and utilities required to run the business are generally tax deductible. If your small business pays rent for the use of a property that your business does not own, the rent can be deducted as a business expense. Not to be confused with the home office deduction, in which the rules differ. Rent expense is deductible in the year the rent is paid. If a business makes rent payments in advance, the amount deducted is applied to your use of the property during that tax year. Remaining payments must be deducted over the period to which it applies.
Utilities
The amounts paid for utility expenses within a building location, such as a retail store or office building, are deductible business expenses. Business utility expenses include electricity, gas, water, internet and telephone. Keep in mind, for the utility expenses related to your home office, only the business percentage usage of your utility payments can be deducted.
Travel Expenses
All travel expenses in relation to your business are considered deductible business expenses.
Deductible business travel expenses include:
- Airfare, bus or train fares
- Baggage fees
- Lodging expenses
- Dry cleaning and laundry expenses
- Taxis, rideshares or limousines
- Meals (limited to 50% deductible)
- Business expenses such as supplies, internet and phone charges
Frequently Asked Questions
Your corporate structure affects tax deductions in the way that it is taxed. In a C Corp, business income and deductions flow through the corporate tax return separate from the owner’s personal tax return and are taxed at the corporate income tax rate. In an S Corp, you owe individual income tax on the income that the corporation allocated to you. In a Sole Proprietorship, business income and deductions flow through your personal federal income tax return, through which you pay taxes on your business earnings at your federal tax rate. In an LLC, whether it is single-member or multi-member, income is reported directly on the individual tax return via Schedule K-1.
The qualified business income (QBI) tax deduction is a tax deduction that allows eligible self-employed individuals and small-business owners of domestic pass-through entities to deduct 20% of their qualified net business income. The QBI deduction is limited to the lesser of the below. It can’t add up to more than 20% of your total taxable income minus net capital gains:
20% of your business net income on the Schedule C plus qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income (PTP).
50% of W-2 wages paid by the business or 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property.
The tax forms that you need to fill out for your small business taxes depend on the type of business structure you have. If you have a sole proprietorship or a single-member LLC business, you will fill out a Schedule C form which you would file with your Form 1040. If your business is a partnership or a multi-member LLC, then you will need to file Form 1065 Partnership return as well as Schedule K-1 for each partner. You need will need to complete Form 1120 U.S. Corporation Income Tax Return for a C-Corp business or Form 1120-S if your business is an S-Corp.
