Tracking expenses and claiming all of the small business tax deductions you’re eligible for can add up to substantial savings, especially for start-ups that reinvest aggressively as they scale. But many entrepreneurs simply don’t know what deductions are available.
This guide covers the basics of tax deductions for small businesses and startups, the deductions available, eligibility requirements by the IRS, and filing requirements.
Many popular tax software are, of course, designed to help you through these startup tax deductions. But the software is only as good as the data. Documenting these things throughout the year is the truly difficult part.
Indinero’s virtual bookkeeping service simplifies record keeping. We’ll paint a financial portrait of your business hat valuably informs your decision-making and protects you in the event of an IRS audit. When the time comes, contact us about our virtual bookkeeping services.
Table of Contents
What Is a Small Business Tax Deduction and How Does It Work?
A small business tax deduction lowers your tax bill by deducting income from your gross revenue. Since businesses pay tax only on profit, this lowers the amount one would pay when filing.
Related: Calculating Gross vs Net Income
But what, exactly, counts as a valid business expense? The IRS paints a broad picture:
To be deductible, a business expense must be both ordinary and necessary. 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 trade or business.
The math behind tax deductions is sometimes misunderstood, so let’s examine the formulas.
Incorrect: (Profit x Tax Rate) – Deduction = IRS Bill
Correct: (Profit – Deduction) x Tax Rate = IRS Bill
In the correct method, the IRS subtracts deductions from profit before multiplying by the tax rate. In other words, deductions lower taxable income before taxes are applied, not after.
The incorrect method would mean a lower overall tax bill, but unfortunately, this isn’t how the math is done.
What small business tax deductions are there?
The IRS’s definition of ‘ordinary and necessary’ is intentionally vague. While individuals are limited to a few deductions, the IRS makes allowances for businesses much more liberally.
Remember, as long as you maintain proper records for what you deduct and can justify these claims as “ordinary and necessary” for your business, you’re probably in the clear. That being said, having a certified small business tax professional look things over is always best.
The rules will vary, but the following deductions are available to LLCs, sole proprietorships, C-corps, S-corps, and partnerships.
- Inventory: In addition to the cost of purchasing, if the inventory value has decreased since the last tax year, you can also deduct that.
- Utilities such as internet, electricity, or garbage collection are fully deductible.
- Interest paid on business loans is fully deductible. You must go through a traditional lender; friends and family don’t count.
Rental fees from offices to printers and heavy machinery; the entirety of the cost of renting property for your business is deductible.
It all starts with having your books organized. Taxes aren’t that difficult if you have your accounting squared away.”
– Jessica Mah, Co-founder & CEO of indinero
Whether you’re scrambling to make your 2016 tax deadline or are unsure which expenses you can deduct, well-organized bookkeeping will be your best friend. Not only will it make it easy for your to reference data if you file on your own, but having ready access to detailed records will also make it easy to solicit help from a tax professional or CPA who will need to understand your business and its year-long activities.
- Real estate: If your business owns your office or other property, the entirety of interest on the loan, property taxes, maintenance, and repair costs are fully deductible.
- Insurance such as health, malpractice, or unemployment is fully deductible.
- Auto expenses: IRS form 463 explains that owners can deduct a certain amount of money per mile they drive. You may also deduct interest on auto loans, maintenance, and depreciation. The IRS provides more details on travel expenses here.
Your choice of cash vs. accrual accounting affects how depreciation is calculated on your taxes. An indinero accounting and tax services professional can advise on the correct strategic decision for your business.
- Office supplies, both small and large, may be deducted. This includes everything from paper and pens to furniture, printers, and coffee machines.
- Software subscriptions are deductible.
- Marketing expenses from materials to outsourcing labor are fully deductible.
- Travel expenses such as airfare, lodging, and conference tickets are fully deductible. Meals while traveling can also be credited towards your taxes but only up to 50%. To qualify, you must leave your home for longer than a normal workday and spend most of your time doing business.
- Bad debt: If you’ve made a loan for business purposes that wasn’t repaid or had a client fail to pay for an invoice, you can potentially write this off as bad debt subject to specific IRS guidelines. For a bad debt, if you lent money to friends or family understanding they may not repay, this must be considered a gift and is not deductible.
- Taxes: You may deduct state, local, and foreign income taxes from your federal tax liability. Additionally, state & local property and sales taxes may also be deducted.
FYI: Business owners can take personal income tax deductions as well as business tax deductions.
- Employee salaries are deductible if they aren’t partners or LLC members.
- Employee benefits like healthcare premium contributions, 401(k) matching, and tuition reimbursement.
- Gifts to employees of up to $25 per person per year.
- Contract labor: Similar to employee salaries, money paid to contractors is deductible. If you’ve paid an individual more than $600 in a year, issue them a MISC-1099 form.
- Legal and professional fees from accountants to lawyers are all 100% deductible.
- Business meals: If you have a meal with a business contact, up to fifty percent of the cost of food and drink is deductible.
- IRA contributions reduce your taxable income by the entire amount in the year you make the contribution.
What If I Use My Personal Home or Car For Business?
You can deduct the portion of your car or home’s expenses related to business use. For your car, that’s measured in miles traveled, and for your home that’s measured in square footage.
For example, suppose 10% of your home is dedicated office space for business use. In that case, 10% of your yearly mortgage interest, rent, utilities, or other expenses such as home repairs are deductible business expenses.
If you drove 10,000 during the year, and 6,000 were for business, 60% of your car expenses, such as gas, oil changes, repairs, or insurance, are deductible.
Tax deductions vs. tax credits
Tax credits are slightly different than tax deductions. They both lower tax liability by reducing taxable income, but the difference is if you get enough credits, you get a refund. Tax credits are efforts specifically implemented by legislators to incentivize certain businesses and behaviors. They’re serious enough about the incentive that they’ll sometimes pay you instead of the other way around.
You can find a comprehensive list and filing instructions on the business tax credits page of the IRS website.
Additionally, we’ve written about The Employee Retention Tax Credit. We also provide R&D Tax Credit Services to businesses seeking to apply for this potentially complex deduction.
Startup Taxes: Requirements for Deductions
If you ever face an IRS audit, you must provide evidence that your claimed expenses were deductible. You’ll need:
1. Receipts and records documenting all expenses
2. A bookkeeping system
That’s it! It may sound easy, but keeping track of all your costs becomes more challenging and time-consuming as your business gets more complex.
You can make this process easier and spare yourself the clutter of the shoebox method. Choose a bookkeeping solution allowing you to upload and store your receipts.
Of the many accounting solutions, the best ones give you concrete financial data to make the best decisions for your business and taxes.
Find out what we mean by booking a call with an indinero expert today.
Keep in mind sometimes a receipt isn’t enough. Certain expenses require specific records. Deducting a personal car is one example. In this case, keep a log of miles traveled and receipts.
Whether you’re scrambling to make your next tax deadline or are unsure which expenses you can deduct, well-organized bookkeeping will be your best friend. Not only will it make it easy for you to reference data if you file independently, but having ready access to detailed records will also make it easy to solicit help from an accounting service provider.