Top 20 Tax Deductions for Small Businesses
The IRC (Internal Business Code) is designed to provide any business with tax deductions, regardless if you are a registered business or a sole proprietor.
Recently, the Tax Reform Law of 2017 (implemented in 2018), TaxCuts and Jobs Act included several amendments to allow increased tax deductions for businesses and business owners.
To help you reduce your taxes as much as possible, this article discusses the following in detail.
- The meaning of tax deductions
- Impact of tax deductions on small businesses
- Eligibility to leverage tax deductions
- Top 20 small business tax deductions
What is a Tax Deduction?
Simply put, a tax deduction is a deduction that reduces tax liability by lowering the amount of income you must pay tax on. These deductions are nothing but the expenses you make to run your small business, as long as they are common in your industry and a legitimate cost of your company doing business.
According to the National Federation of Independent Business, most small businesses do not pay taxes at the business rate. The reason lies in their business structure, and the deductions they are allowed to take. Roughly 75% of small business models are not corporations and are structures that are taxed as ‘pass through entities’, allowing them to be taxed and take deductions at the personal tax rate.
How do Tax Deductions Impact a Small Business?
Several small businesses have little to no profit margins, especially within the first few years of starting the company. Knowing this, it is critical to determine how best to reduce your tax burden to help keep your money reinvesting in the business, instead of flowing to the government.
Further, it is important to note that 9 out of 10 startups fail, and though there are many reasons for this, one key reason as pointed out in a recent survey across 11 countries, small businesses pay more tax per dollar than their well established business counterpart. Simply put, the tax rate per dollar is higher when you are a small company and this can create issues with recently started ventures when not managed correctly.
To counter this, small business owners are entitled to many deductions on their personal and business tax returns, and by using these efficiently these savvy entrepreneurs are able to reduce the taxes they owe by thousands of dollars. This gives business owners an opportunity to save money, reinvest into their business, and most importantly, focus on their cash flow.
In order to optimize your deductions and help your business grow efficiently, one of the best solutions is having a CPA help file your taxes to ensure you write off all available deductions.
How Does a CPA Help Decrease Your Taxes?
A CPA will guide you through ways to structure your company to be allowed to deduct more items, or reduce your overall tax bill with a change as simple as changing from an LLC to being taxed as an S Corporation. Often, hiring a professional will help you save more in taxes than it costs, and will allow you as the business owner to focus on growing your business. Consider hiring a CPA for some of the following reasons.
Tax filing Assistance
CPAs are licensed and experienced individuals. They use their knowledge to prepare and file your taxes providing projections and recommendations before year end to reduce taxes, and by making exact calculations for tax deductions for your personal and business structure.
Determine effective business strategies for proper asset management
CPAs safeguard data with their record-keeping role in the company. It is often required to deliver information-driven solutions that lead to a better outcome for a business’ growth and reduction in taxes..
Help make critical business decisions
CPAs use financial records and statements to help you make important decisions, such as investing in new ventures, hiring, and determining cost cutting measures, all with the business’ best interest in mind.
Reduce business costs by alleviating errors in tax payment
Most businesses make mistakes in tax filing which cost them penalties, interest, and worst of all, time to fix correctly. CPAs ensure that you do not have these errors, and instead bring the peace of mind that the strategies they bring to you can be considered with confidence for building your business.
While, working with a CPA may seem costly, it will save you more in the long run and allow you to focus on growing your business knowing your finances are in order. You may or may not be in a position to hire an accountant, so to work on a budget when starting up consult with a CPA for an hour or two on your business dealings, the best structure based on what you share, and what financial and accounting records to keep track of throughout the year to keep your costs down when you come back to hire them for tax filings.
Do You Have to Have a Registered Business to Deduct from Your Taxes?
You don’t need to have a registered business to deduct from your taxes. Sole Proprietors running their small business, or even as a freelancer working from the home, you can leverage the benefits of deductions permitted by the IRS which are often more extensive than people realize.
However, if you do not have a registered entity, you would be taxed as a sole proprietor and need to file the correct version of Schedule C to calculate the tax on your business dealings. Other positive news is that if you are a startup and technically lose money the first year, this can offset other income you may have, and while we never suggest trying to lose money in a business venture, it is nice to know you can at least use this to you benefit in some way.
The IRS allows freelancers to deduct expenses such as home office space, office supplies, hardware and software, health insurance, insurance premiums, advertising, travel expenses, internet and phone bills, etc. but requires that you keep quality records of these deductions in the event of an audit down the road.
Top 20 Tax Deductions Every Small Business Owner Should Know About
There are too many deductions available to count, so we suggest focusing on some of the key deductions that often provide the largest impact for small business owners and freelancers. The small business tax deduction checklist for 2021 includes the following:
1) Home Office Deduction
Do you work from home? If so, designate a certain part of your home for business-related activities to use specifically for this purpose. This will make you eligible to deduct the portion of your rent or mortgage associated with using this space. Just determine the percentage of the home’s total square footage used for business activities, and multiply this % by the total rent or mortgage you pay to know roughly how much to deduct. As always, this can be a bit tricky, so consult with a CPA to ensure you are taking the appropriate amount of deduction and avoid an audit.
2) Phone and Internet
All expenses made towards telephone and internet services for your day-to-day business activity are eligible for small business tax deductions in the % they are dedicated to business activities. However, if you use a landline at home for business, you cannot make deductions for the first line you have; you have to have a second connection to be eligible for your tax deduction on phone and internet.
3) Meals and Entertainment
50% of the meal amount can be deducted, provided it is for a meal related to a business purpose, and you have proper documentation of the event. While documenting, include date and place of the meal, business relationship with the people present, and the total expense.
To track business meals and entertainment expenses, maintain the receipts and other details over the course of each year. Software such as Quickbooks can allow you to take a picture with your phone of the receipt, and categorize it right in the moment to simplify your accounting procedures.
4) Employee Pay or 1099 Contracted pay
Paying salaries, bonuses, wages, commissions, and taxable benefits are considered tax deductible expenses. However, for this to count the employee can not be a partner, the sole proprietor, or an LLC member in your business. As long as the salary amount is rational and reasonable, and the services given are provided in relation to your regular and reasonable business activity you can deduct the cost of these services.
5) Branding/Marketing/Advertising Cost
You can deduct almost any costs to market your business. This includes all the possible media including print and digital advertising, printing business cards or signs, company swag you hand out, website design and maintenance.
6) Healthcare Premiums
If you pay healthcare costs out of pocket as a sole proprietor, and are not provided benefits by any other employer then you may be eligible to deduct some of the cost of your healthcare premiums and potential even healthcare costs. There are very specific rules and regulations to take advantage of this deduction, but when you are able to take advantage of this it often provides a large amount of benefit, and can quickly become worth hiring a CPA in order to reduce your tax.
7) Life, Disability, and Long Term Care Insurance Benefits
Depending on the structure of your business you may be eligible to pay for the cost of life, disability, and long term care insurance. The costs of these benefits may not be as high as healthcare premiums, but in some business structures you are able to provide yourself some of these benefits and take a tax deduction. These are case by case situations, and often a smaller tax deduction than others listed here, but worth consulting with your CPA over.
8) Travel expenses
Expenditure such as airfare, rental car expenses, hotels, meals, dry cleaning account for it. However, your travel must fulfil certain conditions to ensure it is, in fact, related to your business. If the expenses do qualify, then you are likely able to write off a majority of all work-related travel expenses, and drastically reduce the amount of tax you owe.
To consider if this is deductible, be sure the travel is necessary for your business, is away from the city where you operate your business, and longer than one day.
9) Equipment Expenses
Equipment of several kinds qualifies for 100 per cent tax deductions. This includes office equipment such as computers, scanners, and printers. If working from home/office. You can leverage 30% small business tax deduction for making alternative energy equipment such as solar water heaters, solar panels, and wind turbines.
Business equipment, if moved from one location to another, is also tax-deductible.
10) Office Expenses
Often business have a large amount of general office expenses. Costs such as printers and ink, paper, pens, software, postage, shipping costs, and many other items qualify for this. For example, furniture bought for the office is 100% deductible, however it must be bought be bought in the same year, and you must determine based on the cost if you are going to deduct or depreciate the assets. Depreciation is a difficult process and nearly always requires a CPA to ensure it is done correctly. Most importantly, keep the receipts for these purchases; as you would need them for your tax filing and in the event of an audit.
11) Bank Fees
You can deduct fees for paying bills, or transferring funds. Further, any overdraft fees, service charges, and later fees associated to your credit card account or business bank. If business related, transaction fees paid to a third-party payment processor or merchant is also tax-deductible.
12) Business Gifts
Your deductible small business expenses include gifts for customers, clients, employees, and other business associates. You can give any gift you want, as long as there is no specific law preventing the gift, and to take a deduction just remember that you can only deduct up to $25 of any gift, even if the gift is more than $25.
13) Business Use of your Vehicle
The entire cost of running your vehicle for business needs is deductible. However, if you are also using it for personal errands, then deduct the cost. To deduct office expenses, including gas and toll, paid for meeting business clients.
You can calculate it in two ways:
Standard Mileage Rate is driven in the tax year and multiply it with standard mileage deduction. (at present, it is $0.56, and you can check for updates here)
Actual expense method: Add all the payments made to run the vehicle, such as repairs, gas, oil, insurance, tires, tolls, lease payment, and registration fee. Multiply the number with the miles you have driven for business in the tax year.
14) Charity
Sole proprietors, partnerships, and limited liability companies (LLCs) cannot deduct charitable contributions on the business expense. However, the owner can write it off as per Schedule A. Corporations can get up to 25% of their taxable income on charitable contributions. Always consult with a CPA if you plan to do this, especially if you plan to donate to political parties.
15) Cleaning supplies
For maintaining sanitation at your business premises, you can claim a tax deduction. This includes trash supplies, cleaning supplies, sanitation, and recycling. If owning a home/office, you can deduct a part of the payment made to the cleaning service or the individual, but often is not worth the hassle of tracking costs and using this deduction.
16) Depreciation
At the current time, you don’t need to depreciate assets. Due to recent tax reforms you can now deduct the new purchase’s entire cost of items such as furniture, computer, and equipment. However, you should continue to stay knowledgeable on how any current administration impacts the tax laws.
17) Startup Costs
Lastly, you can claim a small business tax deduction for your startup cost. This includes money invested in acquiring or opening a business. This also includes travel and expenditure to find suppliers, distributors, and customers apart from advertising. The deductible start up cost changes over time, and more information on the current rules can be found here.
18) Professional service fees
Fortunately, nearly all necessary professional services, including bookkeeping, accounting, and legal, are deductible. If you are using any software for bookkeeping or accounting, that purchase is also deductible. This is why we recommend leveraging a CPA, accountant, and bookkeeping team if this isn’t your strongest subject. Not only does their advice often outweigh their costs, but their costs are deductible and even reduce your tax making it a win – win decision to hire a professional.
19) Rent or Building Ownership Costs
Rent or mortgage costs for the location you operate your business from can be deducted as a business expense. This can often be a large expense, and an underutilized business strategy when it comes to owning the building you operate in. Having the business own a building that your company pays rent in can be a magnificent business and tax efficient strategy, but should never be attempted without prior advice from professionals on business structure, and a thorough understanding of how the strategy is most optimal. Further, if you are using your home for operations, you cannot deduct the entire payment made.
20) Interest Costs
Interest is charged on many items such as business loans, credit cards, or business property ownership. The interest amounts are often deductible if used for business purposes, and can add up to large amounts depending on the type of business you run. It is especially important to consider if you own real estate, or take access to capital to fund new projects.
Bottom Line
Small business tax deductions in 2021 vary for different business structures and from state-to-state. So, use this checklist to kick off your tax reduction strategies, and it will help you save money on taxes so that you have more leftover to reinvest in your business and its growth.
Please know that not every item will apply to your business model or situation, and the absolutely best tax reduction strategy is to hire a CPA. Seeking advice from a professional at the earliest opportunity is advised, so that you can make a tax plan before the year is out; and remember, the money spent on a tax consultant is tax deductible.
