Fact: Every adult citizen or resident of the United States of America is familiar with the concept of taxes. This also includes U.S. organizations who file and pay taxes each year and are required to follow business tax laws.
Behind those businesses, companies, nonprofits, etc., are owners, partners, and founders who find themselves juggling both business and personal tax codes. Needless to say, this can get confusing. Every business is different and every business owner has their own unique situation, so understanding what tax responsibilities and opportunities do or do not apply to you as a taxpaying business owner is not always easy to decipher—especially not on the IRS’s website.
That’s where indinero and Trinet decided to put their heads—and Twitter followers—together! Our two organizations are dedicated to helping business owners run companies with healthy employees and happy bank accounts. So, earlier in February both teams put their Twitter handles and LinkedIn profiles to work to see what burning questions small-to-medium businesses (SMBs) have about tax season.
You asked, indinero Answered!
We received a wide array of questions from what types of insurance you can and cannot write-off on your taxes to strategies for anticipating and planning tax-related fees from activities that arise over the course of a year. From there, indinero’s tax experts we happy to dive in and explain the overall concepts, best practices, and next steps business owners should know. Enjoy!
Expert Answers to Your Business Tax Questions
Q: What employer-required expenses can be written off?
Business expenses are the cost of carrying on a trade or business. These expenses are usually deductible if the business operates to make a profit.
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.
Example: take employer related expenses. Worker compensation insurance expenses are deductible, as are bonuses. Both of these expenses are a part of your employee compensation. An employee recognition event, for instance, the holiday party or a summer picnic, is also a deductible business expense.
On the flip side, some business costs must be capitalized, rather than deducted. The costs related to remodeling a waiting room or lobby may not be immediately deductible because they are considered an investment in your business and are called capital expenses. Capital expenses are considered assets in your business. Capital expenditures include the costs of acquisition or construction of buildings, machinery and equipment and furniture and fixtures. Generally, if a cost extends the useful life of property or adds to its value, it must be capitalized.
What can be deducted in this situation is the depreciation of value. It’s possible to actually accelerate depreciation and move a large portion, or all of the deduction related to the capital asset into the current year, but the rules are complex.
Businesses cannot deduct personal, living, or family expenses. However, if an expense for something that is used partly for business and partly for personal purposes, you can divide the total cost between the business and personal parts and deduct the business portion.
Q: If a business owner or employee works from home, what types of overhead costs (i.e. internet, electricity, heating) can they apply to the home office deduction?
In order for any part of your home to be deductible the “work space” needs to be used regularly and exclusively for business. The “exclusive” test is what disqualifies most taxpayers from claiming this. If there is a TV or anything personal in the room, it likely is not “exclusively” used for business. Hallways/Kitchens/Bathrooms or other similar rooms would almost never pass the exclusive test.
Once you have determined the portion of your home that is used exclusively and regularly for business, you use that to determine what expenses are deductible.
Example: if you’re a graphic designer who works from home and uses 10% of the square footage of your home exclusively and regularly for business, 10% of your rent or mortgage, utility bills, property taxes, etc. would be a business expense. In addition to your normal living expenses, 10% of the applicable depreciation for any capitalized fixed assets, such as the home itself, would also be deductible.
As a business owner, you need to be careful with how you reimburse yourself for these expenses. The three main options are:
- Have the company pay the “employee” rent for the use of the space. This would be deductible to the company and rental income to the individual homeowner.
- The individual could claim the home office deduction for the use of their home. This would be an additional filing with their individual income tax return and would give the homeowner a deduction at the individual level. The business would not be affected.
- The company could reimburse the employee through an accountable plan through payroll. As long as this was setup properly and the expenses qualified the reimbursement would be deductible to the company and come through tax-free to the employee.
Q: What types of business travel expenses can you deduct?
First, determine your tax home. Your tax home is the primary location where you produce income. If your business is located in San Francisco, that is your tax home. You must travel away from your tax home to incur deductible travel expense: Read more about determining your tax home and qualifying travel expenses here.
Like all business expenses, business travel expenses must be “ordinary and necessary”. In this case, “traveling away from home” would be a trip that requires you or an employee to be away from your tax home overnight.
The following travel expenses are deductible:
- Travel by plane, train, bus, or car between your home and your business
- Using your car while at your business destination (standard mileage rate, tolls and parking fees, car rental)
- Fares for taxis or other types of transportation
- Meals and lodging
- Dry cleaning and laundry
- Business calls while on your business trip (this includes business communications by fax machine or other communication devices)
- Shipping baggage or materials
- Other similar ordinary and necessary expenses related to your business travel (these expenses might include transportation to and from a business meal, public stenographer’s fees, computer rental fees, and operating and maintaining a house trailer)
As always, keep detailed records and receipts. The IRS closely scrutinizes these types of deductions.
Q: What insurance costs can a business owner write-off?
Almost all insurance costs that are ordinary and necessary to a person’s business are deductible. One unique exception, however, is life insurance. This is because the premiums are not deductible. This may seem unfair, but if the company were to collect on a life insurance policy, the proceeds would also not be taxable.
Q: How can self-employed taxpayers (sole proprietors, S-Corp shareholders, contractors or partners) manage money throughout the year to budget for tax expenses?
The biggest thing here is just knowing that, unlike W-2 wages of an employee, self-employed earners don’t have anything withheld from the income they earn.
Every time an employee gets paid their employer is required to withhold a certain amount from their paycheck and pay that to the various taxing authorities before they receive their wage. Then at the end of the year, the total amount of tax that has been withheld is fairly close to the total tax due (which will likely result in a small refund or small amount due).
Self-employed individuals don’t have any withholdings so unless they make estimated payments throughout the year they will be liable for the entire year’s tax when they file their tax return (this can be very surprising if you’re not expecting it). Unfortunately, because of the various tax brackets and additional self-employment taxes applicable to self-employed individuals, calculating how much to pay each quarter can be very complicated.
Safe Harbor Alternative – What to Know:
A quicker solution is to just pay the safe harbor each quarter. This involves paying 25% of prior year’s tax each quarter, or, if your income was greater than $150,000 in the prior year, 27.5% of prior year’s tax each quarter. As long as you pay this amount you will avoid interest and penalties throughout the year.
But do your homework! Because the safe harbor is based off of prior year income, it’s not always the best solution for taxpayers with a much smaller tax liability as compared to prior year. Using the safe harbor in this scenario would result in paying way more tax than you need to and essentially giving the IRS an interest-free loan until you claim your refund when you file your tax return. If your prior year liability is substantial and you think you will fall into this scenario it may be wise to hire a tax professional to calculate your quarterly tax due each quarter.
Note: This is for federal taxes. Many states have a similar safe harbor rule but each state is different so you should research those rules specifically.
Do you have more questions about business taxes?
This kind of feedback is essential to proactively tackling any problems that hinder business owners’ momentum this time of year. After all, taxes are complex and the deeper you get into your personal and business tax filing, the more questions arise (and the more specific they get).
If you’re curious about any of the topics above or have questions of your own, shoot us a comment below OR contact us to speak with a financial consultant about your specific business’s taxes. We recommend the latter for any inquiries that tread on the confidential side.
And if you haven’t yet, I highly recommend reading through our business tax kit for helping entrepreneurs meet their tax season objectives:
- Getting books organized
- Meeting deadlines
- Lowering taxable income.
This free three-piece resource pack also includes a checklist for tax-ready financial reports and a fillable worksheet to organize your company’s essential tax data before meeting with a CPA.
Editor’s Note: This article is based on a prior post indinero’s content manager, Melissa shared via our friends over at Trinet. View that original post here.
Cover photo by flickr user USDAGov.