Welcome to STA’s most recent blog with the goal of clearing away the financial fog!
This week, we explore the specific expense categories eligible for tax deductions.
A major pro of starting a business is the tax credits and deductions that follow.
In this particular blog, we describe the differences between the two and list some deductions your business can be eligible to receive each year.
Tax credits directly reduce the amount of tax you owe, giving you a dollar-for-dollar reduction of your tax liability. A tax credit valued at $1,000, for instance, lowers your tax bill by the corresponding $1,000.
Tax deductions, on the other hand, reduce how much of your income is subject to taxes.
Tax Credits – or rather, an accumulation of tax credits which directly and actionably reduces your tax bill.
So, how TAX CREDITS work are “below the line” – they reduce your after-tax TAX BILL by a dollar-for-dollar amount, based on certain activities and qualifications you meet for the IRS.
According to the IRS, “small business tax deductions, also called ‘write-offs’ are business-related expenses that you can subtract from your taxable income.
According to the IRS, business expenses must be both ordinary and necessary to be considered deductible. An expense is “ordinary” if it's common and accepted in your industry or business. An expense is “necessary” if it’s helpful and appropriate to your business.
An expense generally doesn’t have to be indispensable or “absolutely necessary”, in order to be considered necessary [at the time].”
The following are examples of eligible tax deductible categories for your business:
Startup and organizational costs
- Include consulting fees and amounts to analyze the potential for a new business, expenditures to advertise the new business, and payments to employees before the business opens. Startup costs do not include costs for interest, taxes, and research and experimentation
- Note: You must value inventory at the beginning and end of each tax year to determine your cost of goods sold.
Expenses that go into figuring the cost of goods sold:
The cost of products or raw materials, including freight
Direct labor costs (including contributions to pensions or annuity plans) for workers who produce the products
- The cost of the business owner’s health insurance, business continuation insurance and the business owner’s policy are all 100% deductible
- Other types of deductible insurance policies include property insurance, liability coverage, malpractice insurance, workers’ compensation costs, auto insurance, business provided employee life insurance and business interruption insurance.
- You have to have records that prove business usage, as well as keep track of your mileage.
- Or, you can rely on the IRS standard mileage rate, which is currently $0.58 cents per mile.
Rent and depreciation on equipment and machinery
- If you lease equipment or machinery for your business you can fully deduct these costs. This can be anything from printers and copiers, to vans and trucks
Business property rent
Employee benefits programs
- Note that most meal costs are only deductible up to 50%. But certain types of meals, such as a meal provided at an office party, are 100% deductible.
- If you have a small-business loan, interest payments are usually fully tax deductible as long as the loan is used to cover business expenses. The loan must be through a traditional lender, and not a friend or family member
- If you’ve ever lent money to an employee or vendor without receiving it back, you can claim that back as ‘bad debt’. You just need to be able to prove that it was business debt, rather than personal debt.
Loans to clients, suppliers, distributors and employees
Credit sales to customers
Business loan guarantees
- Federal, state and local income, real estate or sales taxes. Your employer taxes, such as employer share of FICA, FUTA and state unemployment taxes, are also fully deductible.
- This includes bonuses and commissions. Deduction does not apply to sole proprietors, partners and LLC members, because these individuals are not considered employees.
- Employee gifts are 100% deductible up to $25 per year, per employee, per the IRS.
Note that you must issue form MISC-1099 to any contract worker receiving $600 or more from you in a given tax year.
If the employee is being paid via credit card or PayPal, the payment processor must issue the worker form 1099-K.
Legal and professional fees - If you need to hire a legal or accounting professional for business purposes, you can deduct 100% :)
Keep your receipts and other documents and then organize them into specific categories in time for tax season.
You need to keep detailed records in the form of bookkeeping & digitizing your receipts in order to actually validate these write-offs!