When you bring in hard-earned cash as a small business owner, you certainly don’t want to overpay on your taxes. And as we saw in the previous section of this Tax Series, What Taxes a Small Business Pays, there are several different taxes you're responsible for paying. Any way your business can save is worthwhile. Here’s a look at the business deductions you may be entitled to:
Getting your business up and running can be costly. Fortunately, you can deduct many of the costs the first year you’re in business. There’s a $5,000 cap on these expenses the first year. Additional startup expenses can be amortized over the next 15 years.
Money you spend to run your business is deductible if it’s considered by the IRS to be both “ordinary” for your industry and “necessary” to your operation. This includes things such as employee salaries and benefits, inventory costs, office supplies, rent, advertising, utilities, association memberships, postage, and so on. So, remember our tip in part one: hold on to receipts and documentation for these expenses throughout the year.
Fees you pay attorneys, accountants, consultants, and other professionals can be deducted in the year you incurred the charges. If you pay a professional to do work that’s correlated with future business years, those fees need to be deducted over the time period the work will benefit.
You can deduct 100% of the cost of office furniture the year you bought it; or you may choose to deduct part of the expense over seven years, known as depreciation. The latter option is better if you’ve spent a lot of money, as there’s a cap on how much you can deduct for office furniture in one year. The amount may change from year to year, so it’s best to consult with your accountant for the current cap.
Other Office Equipment
Office equipment such as copiers, scanners, computers, and phone systems are tax deductible. As with furniture, you can take 100% of the cost up to the current cap or depreciate it. Office equipment gets depreciated over five years.
Personal Vehicle Use
If you use your own vehicle for business purposes, you’re entitled to be reimbursed for some of the related costs. Except for your commute to and from the office, all work-related driving counts towards a deduction. Keep a mileage log that includes the business purpose involved.
If you work from home, any driving you do for business applies. You can choose to be reimbursed at a flat rate—which is 56 cents per mile for 2015—or as a percentage of your total mileage. The cost for gas, insurance, repairs, and lease or finance payments all count.
Travel, Entertainment, Meals, and Gifts
If you travel for work and are not reimbursed, you can deduct the cost of that from your income. Transportation (like air or rail), lodging and other expenses while on the road (such as tips, rental cars, wifi, etc.) are all deductible.
Meals are deductible at the rate of 50%, which is true whether you’re eating as part of a work trip or having a business-related meal with a current or prospective client. Other customer entertainment expenses are also 50% deductible.
You can deduct 100% of the cost of client or employee gifts up to $25 per person each year. Again, keep accurate and detailed records to be able to prove the expenses are for business.
Businesses can deduct contributions made to recognized charitable organizations. The charities must be eligible under IRS rules.
Subscriptions, Software, Seminars, Trade Shows, and Books
Trade magazines, books, periodicals, and any other publications you use for business purposes are deductible. So is the cost of accounting software, inventory software, or other software your business uses. Changes to the tax code have sometimes required software to be depreciated, so check on this before you file.
If you attend trade shows, conventions, or other industry meetings, either as an attendee or exhibitor, the fees for those are deductible as well.
Credit Card Processing Fees
If your business takes payments on credit cards, the fees you pay for processing are tax deductible.
Training related to your current field is deductible if it’s necessary to keep or improve skills related to your industry, such as certain certifications or licensing. You can’t deduct such costs if you’re going to school or training to change jobs or professions.
If you’re self-employed and pay for your own health insurance, the cost is 100% deductible, but not if you were eligible for other health care coverage, such as health insurance offered by your spouse’s employer. Premiums paid for liability, disability, malpractice, workers' compensation, and credit insurance are also deductible.
Self-employed individuals can also deduct their contributions to IRA and other retirement savings accounts.
Sole proprietors and other self-employed people make twice the Social Security contributions as employees do because the law requires the employer to pay half and the employee to pay half. If you work for yourself, you’re both an employer AND an employee, but you can deduct half of the contribution when you file your tax return.
Many of the taxes you pay during the operation of your business are deductible from your income tax. This includes employment taxes you pay (other than the self-employment tax, which is paid by individuals and not their businesses), state income tax, and real estate taxes on business property. Excise and fuel taxes are also deductible if you’re required to pay them.
If you sell goods or merchandise and get stiffed on an invoice, you can deduct the cost of those goods from your income. Sorry, service providers, the same does not hold true if a client does not pay you for your time.
Interest on credit cards or loans specifically for business purposes are tax deductible. As always, be sure to keep your personal and business spending separate, and be prepared to document the expense.
What is NOT Deductible
Some things you might think would be deductible are not. These include fees for professional exams, business clothing (unless it’s for protective equipment or a uniform that would only be worn for work), federal income tax payments, tax penalty payments, employee or customer gifts valued at more than $25, expenses related to lobbying, and political contributions.
Depending on the business you’re in, there may also be other deductions available to you. If you’re using tax prep software, most will walk you through a list of questions to figure out what else you qualify for. The IRS also has a web page with links to tax tips for a wide variety of industries and professions. You’ll find a wealth of information for restaurants, online sellers, child care providers, construction workers and more.
Another technique you can use is to look at your return from the point of view of the IRS. Check out the Audit Technique Guide the IRS put together for your industry. The guides offer a fascinating and comprehensive look at what an auditor would be checking for when examining your tax return, and each one has a unique list of the types of expenses that type of business can claim.
The Home Office Deduction
The home office deduction is probably one of the most misunderstood deductions available to many small business owners and others who work from home. Because of that, it’s sometimes not taken when it should be, and other times, it trips people up because they take it when they shouldn’t. When used properly, the deduction allows you to deduct some of the expenses for the care and maintenance of the space you’re using for work at home. Let’s clear things up.
How Do I Know if I Qualify for the Home Office Tax Deduction?
The IRS has two criteria you must meet.
1. You REGULARLY use the part of your home you’re claiming as your home office EXCLUSIVELY for conducting business.
Regular use means that occasionally bringing work home on the weekend won’t qualify a space for the home office deduction. You must make recurrent use of a separate room or area in your home dedicated solely to business.
This excludes your dining room table if you also use the space for family gatherings. It means your guest room doesn’t count if you also use it to accommodate out-of-town relatives. It can, however, mean a corner of your basement just used for business, or an actual home office separate and apart from your living space.
If you run a childcare business in your home, the exclusive-use provision does not apply. There are also rules for those who store inventory and/or product samples at home. All of the regulations and exceptions are spelled out in this IRS publication about using your home for business.
2. The space you’re claiming must be your PRINCIPAL place of business.
This qualification is a little tougher to quantify because you’re allowed to conduct business outside of your home (such as meeting with clients and doing on-site work and repairs) as long as you work from home “substantially and regularly.”
Generally speaking, if you do the most important part of your work at home, or use it for administrative or management activities that you don’t do anywhere else (like billing and bookkeeping), you will likely qualify for the home office deduction.
How Does the Home Office Deduction Work?
There are two ways to figure out how much you can deduct. One is to calculate the actual amount of the expenses incurred. To do this, you’d have to substantiate how much you spent, then allocate the correct portion for the business.
Some expenses are deductible in full. These are direct expenses that only apply to the business part of your home. Examples would be any repairs you make to just that space, such as painting or new windows.
Other expenses would be deductible based on what percentage of your home you’re using for work. These indirect expenses are bills you’d pay regardless of whether you had a home office, and include things such as insurance, mortgage or rent payments, utilities, property taxes and general repairs.
To figure out how to apportion these indirect expenses, you would measure your work area and divide by the square footage of your home. For example, if your home office is 10’ x 10’ (100 square feet) and your home is 1,000 square feet, you could deduct 10% of the costs related to running your home (100 ÷ 1,000).
The other way is a far easier method in which you simply multiply the prescribed rate (currently $5) by the square footage of the area of your home you’re using for business, with a top limit of 300 square feet. For the 10’ x 10’ home office example above, you would deduct $500, or $5 times 100 square feet.
You can’t write off more than you make from the business you’re claiming a deduction for, and there may be some additional complications with depreciation, but tax software or your accountant can help you figure that out. Other than that, it’s pretty straightforward, especially if you use the simplified method. To claim the home office deduction, you would file IRS Form 8829, Expenses for Business Use of Your Home.
The bottom line is: if you qualify for the home office deduction, take it; just be prepared to back things up, as you would with all other business and personal deductions.
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