Small business tax deductions are one of the best ways to reduce your taxable income and save money on your taxes. But do you know what expenses you can deduct and how to claim them?
In this article, we will explain the basics of small business tax deductions and give you some tips on how to maximize them.
What are small business tax deductions?
A tax deduction is an expense that you can subtract from your gross income to lower your taxable income. For example, if you earned $50,000 in 2023 and spent $10,000 on deductible business expenses, your taxable income would be $40,000. This means you would pay less tax than if you had no deductions.
Tax deductions are different from tax credits, which directly reduce the amount of tax you owe. For example, if you owe $5,000 in tax and claim a $1,000 tax credit, your tax bill would be $4,000. Tax credits are usually more valuable than tax deductions, but they are also more limited and specific.
What expenses can you deduct as a small business?
The IRS allows you to deduct any ordinary and necessary expenses that you incur to run your business. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your business.
Some examples of common small business tax deductions are:
- Startup and organizational costs: These are the costs of setting up and launching your business, such as legal fees, market research, advertising, and licenses. You can deduct up to $5,000 of these costs in the first year of your business, and amortize the rest over 15 years.
- Inventory: If you manufacture or sell products, you can deduct the cost of the goods you sell, including the raw materials, labor, storage, and shipping. You must value your inventory at the beginning and end of each year to calculate your cost of goods sold.
- Utilities: You can deduct the cost of the utilities you use for your business, such as water, electricity, gas, trash, and phone. If you have a home office, you can deduct a portion of your utilities based on the percentage of your home used for business.
- Insurance: You can deduct the premiums you pay for business insurance, such as general liability, property, professional liability, and workers’ compensation. You can also deduct the cost of health insurance for yourself and your employees, as well as the employer portion of Medicare and Social Security taxes.
- Auto expenses: If you use your car for business purposes, you can deduct the cost of operating and maintaining it. You can either use the standard mileage rate (56 cents per mile in 2023) or the actual expense method (which requires you to keep track of all your car expenses, such as gas, repairs, insurance, and depreciation).
- Business travel expenses: If you travel away from your home for business, you can deduct the cost of transportation, lodging, meals, and entertainment. You must have a clear business purpose for your trip and keep records of your expenses and activities. You can only deduct 50% of your meal and entertainment expenses.
- Employee benefits: If you provide benefits to your employees, such as retirement plans, health savings accounts, education assistance, or fringe benefits, you can deduct the cost of these benefits as a business expense. You can also deduct the salaries, wages, bonuses, commissions, and tips you pay to your employees, as well as the employer portion of payroll taxes.
- Repairs, maintenance, and replacement expenses: You can deduct the cost of repairing, maintaining, or replacing your business property, such as equipment, furniture, or vehicles. However, you cannot deduct the cost of improving your property, such as adding a new feature or increasing its value. These costs must be capitalized and depreciated over time.
- Other operating expenses: You can deduct any other expenses that are related to your business operations, such as advertising, marketing, legal fees, accounting fees, bank fees, office supplies, postage, subscriptions, licenses, permits, dues, and memberships.
How to claim small business tax deductions?
To claim small business tax deductions, you need to keep accurate and complete records of your income and expenses throughout the year. You also need to file the appropriate tax forms and schedules with your tax return.
Depending on your business structure, you may need to file one or more of the following forms:
- Schedule C: This is the form that most sole proprietors and single-member LLCs use to report their business income and expenses. You need to fill out Part II of Schedule C to list your business expenses and calculate your net profit or loss. You then report this amount on Line 3 of Form 1040, your individual income tax return.
- Form 1120: This is the form that C corporations use to report their corporate income and expenses. You need to fill out Schedule A of Form 1120 to list your cost of goods sold and gross profit, and Schedule J to list your deductions and taxable income. You then pay tax on your corporate income at the corporate tax rate, which is 21% in 2023.
- Form 1120-S: This is the form that S corporations use to report their corporate income and expenses. You need to fill out Schedule K of Form 1120-S to list your income, deductions, credits, and other items that affect your shareholders’ tax liability. You then issue Schedule K-1 to each shareholder, showing their share of the corporate income and deductions. The shareholders then report this amount on Schedule E of Form 1040 and pay tax on their individual income tax rate.
- Form 1065: This is the form that partnerships and multi-member LLCs use to report their partnership income and expenses. You need to fill out Schedule K of Form 1065 to list your income, deductions, credits, and other items that affect your partners’ tax liability. You then issue Schedule K-1 to each partner, showing their share of the partnership income and deductions. The partners then report this amount on Schedule E of Form 1040 and pay tax on their individual income tax rate.
Tips to maximize your small business tax deductions
Here are some tips to help you make the most of your small business tax deductions and save money on your taxes:
- Plan ahead: Don’t wait until the end of the year to think about your tax deductions. Plan your expenses throughout the year and keep track of your receipts, invoices, bank statements, and other documents that support your deductions. Use a bookkeeping software or service to organize your records and make tax time easier.
- Know the rules: Make sure you understand the IRS rules and requirements for each deduction you claim. For example, some deductions have limits, thresholds, or special conditions that you need to meet. Some deductions also require you to file additional forms or schedules with your tax return. Consult a tax professional if you have any questions or doubts about your deductions.
- Claim all the deductions you are entitled to: Don’t miss out on any deductions that you qualify for. Review the list of common small business tax deductions above and see if there are any expenses that you overlooked or didn’t know you could deduct. You may be surprised by how much you can save by claiming all the deductions you are eligible for.
I hope this article helps you understand small business tax deductions and how to claim them. If you need more help with your taxes, you can contact me anytime.
