Tax liability is an inevitable part of running a business. Every year business owners have to bear the burden of the tax season, paying taxes for income, payroll, property, sales, and so on. In total, nearly 30% of a businesses’ income is needed to cover all tax payments. According to statistics, the U.S. government received total tax receipts of 3,46 trillion USD within a year. And the money that your company earned is among it! If you are fed up with giving money away for taxes, it is time to find a way to reduce them.
Tax deductions are a key financial tool to cut down on tax overpayments. Look through your profit and loss report and research the applicable tax deductions for your business. You will be surprised how much money you can actually save!
In this article, you will learn what tax deductions are, which expenses are deductible, and how to minimize the risks of the IRS tax audit.
What exactly are tax deductions?
Running a business is inextricably connected with having expenses, such as office maintenance, travel costs, professional services, etc. However, it is possible to offset the losses by using tax deductions.
Tax deductions are legitimate write-offs that decrease SMB’s tax liability. The principle of this accounting mechanism is to deduct expenses from the taxable income. Expenses are accumulated during the year and apply to the gross income at the onset of the tax season. It’s worth mentioning that only expenses that are both ordinary and necessary can be deducted. It means that these expenses are part of the regular business processes of the company.
A list of deductible expenses is regularly published on the IRS official website. However, many SMB owners still remain unaware of them, as the IRS isn’t obliged to inform SMBs about possible tax breaks. Below you will find a list of tax deductions that can apply to SMBs.
8 tax deductions that apply to small businesses
If you make use of your home for commercial purposes (a principal place of work, a place for meeting with partners or clients, a warehouse for products), then you can deduct the expenses on its maintenance, such as electricity and other utility bills. In this case, there are two important issues that are of interest to tax agencies:
- Do you record the expenses for business aims and personal needs separately?
- What exact parts of your home are used for business?
Also, make a note that such home use should be exclusive and regular to be applicable for tax deductions. It means that a business owner should be settled in their home as an office for a long-term period.
Business owners who pay interest have the opportunity to deduct it from the taxable income. Interest expense is a payment charged for the use of money, which was borrowed for business needs, for example, bonds issued by a company. The interest paid to bondholders decreases the taxable income and, as a result, the amount of taxes.
Legal and professional fees
Though accounting, legal, and consulting services help a lot with business development, they are very expensive. The assistance of a fancy business consultant can cost a fortune for an SMB. However, even these expenses can be offset from your income by tax deductions. As a result, the net price of your bookkeeper or attorney will be much lower.
Do you use a car or a truck for business? If yes then, you can record the expenses for gas, parking, technical services, and other maintenance costs to lower the taxable income. Lease payments and interest on your car loan can be deducted as well. If you want to apply this type of tax deduction, you should remember to distinguish between personal and business car use. For example, you can record a mileage log. You can find the rates of deductions of auto expenses in the IRS Standard Mileage Rate.
Literally, all rent expenses on business properties are deductible. You can save money on taxes for the rent of offices, factories, shops, warehouses, and so on. The only requirement is to use such a property for business or trade. Plus, tax deductions cover electricity and cleaning services expenses.
Salaries and benefits
For business owners who have employees, the good news is that salaries, wages, bonuses, and commissions are deductible. Besides, SMB owners can deduct their payroll tax. It doesn’t apply to the federal taxes or the FICA taxes, only to an employer portion of the payroll tax.
Phone, internet, and office supply expenses
Surprisingly, many business owners forget or neglect these kinds of tax deductions, even though they are easy to calculate and very useful in running a business. Every time you pay for a mobile connection, internet access, paper, ink cartridges, or other office supplies, you can deduct these expenses from your income. It may seem like insignificant money-wasting, however, in the perspective of the year, it is a decent amount of money that you could put back into the business flow.
If your job is connected with traveling, you can use these expenses to reduce your tax liability. These kinds of tax deductions cover not only tickets but also accommodation and other travel-related costs (even tips in restaurants!). But don’t confuse them with local commuting costs, such as expenses of getting to and from the workplace. These expenses are not deductible.
Overall, the list of deductible expenses is even longer. It is hardly possible to mention all of them as they can vary depending on the structure of the business. For example, self-employed people can also deduct expenses on health insurance for themselves and their dependents, from the income. In turn, sole proprietorships, partnerships, and S corporations can apply a qualified business income (QBI) deduction. There are also dozens of tax deductions on the property, franchise, advertising, and other expenses. However, this list included the most common tax deductions that your company can face.
How to ensure your tax deductions are accurate?
There is a myth that the application of tax deductions can increase the likelihood of tax audits by the IRS. However, it is greatly exaggerated! If you qualify for the tax deduction, there is no reason to worry about a tax audit. Nevertheless, you can take some steps to ensure that your tax deductions are absolutely correct and applicable.
Tax deductions have their own rules for business recordkeeping. It requires systematic and detailed information about every payment you received or made. Here is where online accounting programs can help. Smart finance software such as Synder records all historical and ongoing transactions into your books and provides classified data about each payment (fee, discount, shipping, inventory, etc). In addition, it will track your income and expenses without requiring manual entry.
Plan your expenses
In a business environment, it is highly important to plan your expenses beforehand to minimize financial losses. You should remember that sometimes there are different types of tax deductions that are applicable to the same kinds of expenses. For example, the expenses on car use can be deducted by claiming actual costs or applying an IRS standard mileage rate. By planning it in advance, you will be able to choose a better option for the tax deduction for your business.
Separate personal and business expenses
It is one of the most painful topics in tax deductions. Most often, the reason for the IRS tax audit are precisely the errors in the calculation of personal and business expenses. It especially concerns expenses on auto, home office, telephone, and the internet, where it is hard to divide the use for personal needs from business aims. To minimize the risk of such mistakes, you should track both kinds of expenses very clearly.
Additionally, the IRS highlights the importance of distinguishing business expenses from:
- The expenses used to figure the cost of goods sold
- Capital Expenses.
These expenses are NOT deductible.
Keep an eye on tax law changes
The list of deductible expenses is constantly changing in the IRS new publications. By tracking all changes in the legislation, you can take advantage of additional tax opportunities that other businesses have no idea about. Sometimes, tax reliefs and deductions are introduced as a reaction to the social and political news. And if you, as a business owner, are aware of them, you will be able to save money and make your company much more profitable.
All in all, don’t hesitate to apply for professional accounting assistance to find out new ways to reduce taxable income and ensure that all deduction methods apply to your business. Otherwise, one mistake can make your tax bill grow even more.
Keeping up with all the ins and outs of tax deductions is rather complicated. It calls for hard work on bookkeeping and recording expenses. You can automate your accounting by using online software to help with this. Optimizing tax filing to save money on tax payments is well worth the effort.
Share with us your tax deduction experience in the comments below!