As a small business owner, you work hard for the money you earn and every penny matters. Tax deductions can help minimize your overall income tax bill, which might increase your return and reduce the amount of tax that you owe the IRS. Educate yourself on the small business tax deductions available to you and your business so the investments you’ve made over the past year can be accounted for. The more money you save during tax time, the more you will have to spend on growing your business.
What are Small Business Tax Deductions?
Also known as a tax write-off, small business deductions are expenses you can deduct from your taxable income. Less taxable income means you have a smaller tax bill and owe the government less money.
Tax season can be tough to navigate, and there are common mistakes you’ll want to avoid when filing business taxes, so consulting a professional accountant may be a good idea. Even if you don’t lean on the support of an accountant year-round, using one for tax season specifically can help you take advantage of as many small business tax deductions as possible.
Pro Tip: Be sure to keep track of all receipts and invoices for your small business to make filing your taxes easier and in case your business is ever audited by the IRS. Having accurate and organized records is important.
Small Business Tax Deductions You Can’t Claim
First, let’s talk about the tax deductions you can’t claim. This way, you can spend less time trying to find loopholes for lost causes and spend more time during tax season ironing out the deductions that you can take advantage of. Small business tax deductions that you can’t take advantage of include:
- Personal salary (if you’re a sole proprietor)
- Political contributions
- Life and disability insurance (if you’re a sole proprietor)
- Small business loans
Now let’s dive into the good stuff — deductions you can claim.
Small Business Tax Deductions You Can Claim
Below is a list of small business tax deductions you can claim when you file your small business taxes.
Self Employment Tax
Self-employment tax is one that a small business owner would pay to fund their Medicare and Social Security. This tax applies to all sole proprietors, freelancer, and independent contractors, although those who earn less than $400 annually are exempt.
The IRS treats this payment towards Medicare and Social Security as a business expense, allowing you to deduct it.
Starting a business takes time, energy, and, of course, money. There are three categories of startup costs that the IRS deems eligible for tax deductions: Creating, opening, and organizing a business. However, you can only take advantage of these startup costs if you actually open your business.
Creating a Business
Deductions can be made on costs related to creating the idea and structure of your business. This may include costs associated with market research, product analysis, labor supply, or the legwork required to find potential office space or vendors.
Preparing to Open Your Business
Claim a deduction on any money invested prior to opening your doors (with the exception of equipment), including employee training, supplier and vendor related work, advertising, or legal and consulting fees.
Deductions can be made on costs associated with registering and legally setting up your business structure. This can be deducted if done within the first year of business. Additional deductions may be made for costs associated with legal fees, state organization fees, salaries for temporary employees and organizational meetings, or accounting fees.
Tax Deductions for Operations
Salaries & Benefits
With the exception of your salary if you are a sole proprietor, a partner, or LLC company, you can deduct money spent on salaries. However, the IRS must view these salaries as reasonable for the work being done and necessary to the operations of your business in order for them to qualify. You can also deduct expenses spent on benefits and vacation time provided to employees.
First, it’s always a good idea to have a separate business bank account for your small business. This will help keep your business funds separate from your personal funds. Having an account where you can clearly track spending will be helpful when providing the IRS with the documentation for any deductions you want to claim. Some banks have annual or monthly fees associated with service charges, transfers, or overdrafts. All of these fees are tax-deductible. You can also deduct merchant fees associated with payment processors.
Mobile banking for small businesses is an ideal way of avoiding all hidden banking fees. If you’re looking to add speed and flexibility to your banking while escaping extra costs, this could be a great option for your business.
Similar to salaries, in order for the IRS to accept a deduction for costs associated with business travel, the trip needs to be reasonable and necessary. Additionally, it needs to be outside of your business’s home state where you pay state taxes.
To help clear things up for you, IRS approved travel expenses include the following:
- Requiring you to travel to and from your destination by plane, train, or automobile (again, needs to be out of state)
- Parking and tolls
- Miles put on your personal car. The standard mileage rate is $0.58 per mile.
- Additional methods of transportation such as taxis, subways, or buses
- Meals, lodging, and tips
- Business calls
- Baggage shipping and dry cleaning
Internet and Phone Deductions
Simply put, if internet and telephone services are vital to the operation of your business, then deduct it.
However, the line is a little blurred in this category. If your home office is your home base, then you cannot deduct the costs of your landline should you be using this for both your personal and work affairs. However, if you install a separate landline for business-specific operations, then the cost of this line can be deducted.
If you have a cell phone that you use for both personal and business purposes, you can only deduct costs that have come from calls or data used specifically for your business’s operations. You will need to provide an itemized list of all calls and activities associated with your business.
Business Insurance Deductions
Premiums for business insurance are deductible. The IRS recognizes the following costs as deductible under business insurance:
- Property coverage (This includes furniture and equipment)
- Group health, dental, and vision insurance
- Malpractice and liability insurances
- Auto insurances (for all business vehicles only)
- Employee life insurance
- Business interruption insurances (this covers lost profits if your business closes due to a natural or economic emergency)
Office Rent and Home Office Deductions
If you exclusively work from your home office for business, you may be able to deduct some of your housing expenses as business income. Similar to rent for a separate office space, you can consider the square footage of your home office as a business property.
Deduct $5 per square foot for all space in your home that is used for business. You can do this up to 300 square feet. In addition, keep track of all home expenses used to support your operations. This can include:
- Your mortgage or rent
- Real estate taxes
- Homeowners association fees
Take the sum of these costs and multiply it by the percentage of your home that is dedicated to business operations to figure out the amount you can deduct. For this deduction to qualify you must use your designated business space regularly and exclusively for business use (i.e. don’t set up shop on the kitchen island in the middle of your personal living space. Work boundaries are important, both for tax and mental health purposes — carve out a quiet spot for yourself with a desk.
For rent of a separate business property, you can deduct rental payments over the course of the tax year.
Depreciation refers to the value of a piece of equipment, furniture, or other asset over the years you have and will continue to use them. When factoring in depreciation, you consider how much it cost you to use that asset in a year, rather than consider the total cost upfront. For example, if you buy a new espresso machine for your coffee shop and it costs you $5,000, this would be its upfront cost.
If you assess that its useful life is around 10 years, meaning you’d ideally use this machine for 10 years before investing in a new one, then you’d say the machine cost you $500 each year.
When deducting depreciation, you have several options:
- De minimis safe harbor election: Small businesses can deduct any assets that cost less than $2,500 per year. This is $2,500 per single item.
- Section 179 deduction: This specific deduction allows business owners to deduct up to $1 million of assets during a tax year.
- Bonus depreciation: This lets you deduct 100% of the cost of machinery, equipment, appliances, furniture, or technology. So you can deduct the total cost of an asset over its useful life rather than what it would cost per year.
You can reference past cash flow statements that you’ve created to identify your assets and calculate their depreciation.
Retirement Plan Contributions
This deduction includes contributions you as a business owner have made to your employees’ retirement plans. If you do not have any employees and therefore have only been contributing to your own retirement, then you can file this deduction on Schedule 1, attached to your From 1040.
Health Insurance Expenses
This deduction is in addition to insurance premiums detailed earlier in this post. It includes out-of-pocket medical costs like office co-pays and prescriptions. If you are self-employed, you can deduct these same items for yourself, your spouse, and dependents on Schedule 1.
Child and Dependent Care
If you rely on child care so you can run your business, you can file for a Child and Dependent Care Credit. This credit is worth 20-35 percent of your expenses, which are limited to $3,000 for one dependent or $6,000 if you are actively paying for care services for two or more dependents.
To qualify for this credit, you must meet the following criteria:
- Your child must be under 13 years of age
- Your spouse or dependent must be physically or mentally incapable of self-care
To file for this credit, fill out and attach a Form 2441 to your Form 1040.
Educational costs are fully tax-deductible if you or your employees are continuing your education to improve your business operations and expertise. The following will qualify as deductible expenses:
- Classes to improve your or your employees’ skills
- Industry-related seminars and webinars
- Professional publication subscriptions
- Industry reading (e.g. publications, books)
- Transportation expenses needed to go to and from classes or workshops
Advertising and Marketing
All advertising and marketing efforts are 100 percent deductible and may include the following items:
- Hiring someone for freelance advertising work, such as designing business logos
- Cost of printing business cards and reading materials for your business (e.g. brochures or pamphlets)
- Ad space
- Sending cards or advertising materials to clients
- Website launch
- Social media marketing
- Event sponsorship
One exception to keep in mind is that the IRS will not allow you to deduct any money invested in political campaigns, events, or lobbying.
Taxes and Licenses
The IRS will allow you to deduct costs associated with the following taxes and licenses:
- Business licenses
- State income
- Real estate taxes paid on your business property and personal property tax
- Sales tax
- Excise taxes
If you take out a loan or business credit card to cover business expenses, interest paid to your lender or issuer can be deducted from your taxable income.
To qualify for this deduction, interest paid must come from a debt that you are legally liable for. If you received help from someone else’s debt that they took out to help you, you can’t deduct this interest. If you’ve received a loan that isn’t required to be paid back, then this is treated as a gift rather than a loan. You can’t deduct this.
Lastly, the IRS tends to only honor interest paid to an actual creditor, lender, or issuer. Meaning, if you are paying interest on loan given to you by a family member or friend, this isn’t considered a deductible amount.
The IRS recognizes that legal help and consulting services are necessary for running a business and therefore fees charged by lawyers, accountants, bookkeepers, or online bookkeeping services, and tax preparers can all be deducted from your taxable income.
The IRS will allow you to deduct 50 percent of the total cost of food and beverages. This can be done under the following conditions:
- It must be necessary to your operations
- The meal cannot be extravagant. It must be reasonable and “ordinary” by the IRS’s standards.
- Both the business owner and employee must be present for the meal.
Meals provided at company parties are 100 percent deductible.
Like all of your expenses, keep track of all food purchased for your small business.
This deduction includes costs required to move business equipment, inventory, or supplies from one business property to another.
Whew. Deep breaths. There is a lot of information here, but there are also a lot of opportunities to minimize your taxable income and potentially maximize your tax return. Familiarize yourself with the above guide to small business tax deductions so you can get the most out of tax season.