What is a Tax Deduction?

Filing for taxes can be quite intimidating. And navigating the complexities of taxes can be overwhelming and complicated – especially as a small business owner. Understanding tax deductions and how to claim them can save your business a significant amount. If you’re not quite confident about how they work, we’ve outlined everything you need to know for you! Here, we will define what is a tax deduction, how to claim tax deductions, and give you 10 examples of common tax deductions for small businesses and what is not eligible as a tax deduction.

TABLE OF CONTENTS

Definition of Tax Deduction

How to Claim Tax Deductions

10 Common Tax Deductions for Small Businesses

8 Non-Deductible Expenses for Small Businesses

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Definition of Tax Deduction

A tax deduction is the amount of money an individual or business can deduct from their taxable income resulting in a lower amount of income taxes owed. Tax deductions are also called a tax write off, these words are often used interchangeably. What deductions a filer can claim depends on their status such as individual, business, etc.

Here’s a quick, simple example of how deductions work. A small business owner made $10,000 last year and they have $2,000 worth of deductible expenses, meaning their taxable income for the year is $8,000. Now, the owner will owe taxes according to $8,000 rather than the original $10,000 meaning the amount of taxes paid to the IRS will be reduced. 

Definition of a deductible 

Deductible means an amount that is subtracted from a total. In regards to taxes, deductible is a term used to describe an expense that you do not have to pay tax on. This term is commonly used in the tax realm, but it is also used when talking about insurance policies. Be careful, don’t confuse the two usages! 

Tax deduction vs. Tax Credit

You have likely heard of the term ‘tax credit’ before and assumed it was the same as a tax deduction or similar. However, there is a small, but important difference between these two terms. While a tax deduction or a tax write off, reduces the income, a tax credit reduces tax liability. We won’t go any further into tax credits as this article focuses on deduction, but it is important to note the difference and understand how both can affect the amount of taxes owed. 

How to Claim Tax Deductions

Filing taxes can be tricky. A vital part of your business’ financial planning is claiming taxes and small businesses can claim tax deductions through standard or itemized deductions; depending on their financial situation and expenses. Understanding how standard and itemized deductions can help your business reduce taxable income and overall tax liability will help you determine your next steps. 

Itemized vs Standard deduction

An itemized deduction is a list of specific expenses that can be deducted from your AGI. This is more involved and requires you to maintain records of eligible expenses such as office supplies, travel, and more. Small businesses can deduct the exact amount spent on these items. Itemized deductions could be beneficial for your business if the total amount of money spent on qualified expenses exceeds the standard deduction amount. 

A standard deduction is a fixed dollar amount set by the IRS that can be subtracted from your taxable income. Specifically, for small businesses, the standard deduction is subtracted from the sole proprietor’s personal tax return. This is a more straightforward process when filing because taxpayers do not need to itemize their expenses. It simplifies the filing process; however, this fixed amount may be lower than the itemized deduction. You should take the time and investigate which one would be better for your business. 

To conclude, the main difference between an itemized and standard deduction is that a standard deduction is a set amount determined by the IRS that every business can claim. Whereas, itemized deductions allow small businesses to claim the full amount of qualified expenses which could surpass the standard deduction. Be sure to keep yourself informed of all tax deductible items by reviewing the guidelines set by the IRS. 

10 Common Tax Deductions for Small Businesses

• Advertising and promotion
• Business meals
• Business insurance
• Company use of vehicle
• Contract Labor
• Education
• Home office
• Rent or Lease expense
• Salaries and benefits
• Travel expenses

Advertising and promotion

Any money spent to promote your business is tax deductible. This includes digital, print, and audio advertising such as: 

• Social media ads
• Billboards
• Newspapers and magazines
• Radio commercials

Business meals

Typically business meals can be deducted by 50% as long as they met the two requirements:

1. One business contact is present. This could be a business partner, client, vendor, or prospect. 
2. Conversations should be business related and in the pursuit of making the business more profitable.

Make sure you keep proper documentation such as receipts, record who was present, and the purpose of the meal.

Business Insurance

A variety of business insurance are fully deductible as long as the insurance is essential for your business to operate. The types of business insurance that qualify range from liability to workers’ compensation insurance.

Company use of vehicle

Small business owners have two ways to claim vehicle deductions: standard mileage rate or actual expenses.

Standard mileage rate: This is set by the IRS every year and it will help you calculate your deduction. 

Actual expenses: This requires detailed records of all auto expenses. This method allows you to deduct a percentage of all related costs by determining the percentage of business use of the vehicle. 

Contract Labor

The money used to paid for contracted labor or freelancers is considered as a tax deduction for your business. Be sure to properly document and keep records of all payments made to the contractor as you will be required to file an additional form, Form 1099-NEC, to the IRS. 

Education

Specific skills may be required to operate your business. Therefore, educational expenses such as courses, seminars, and certifications or other professional needs that are essential to run your business qualify as a tax deduction. For example, a teacher will likely be able to deduct the cost of renewing their teaching certificate.

Home office

If you utilize a space in your home solely for the purpose of conducting business, you may qualify. Please refer to the current tax year’s guidelines for up to date information and verify that you are eligible for a deduction. 

Rent or Lease expense

If you rent an office space, warehouse, or storage space and it is necessary for your business this expense is deductible. In addition this applies to any machinery or equipment that is an essential part of business. As always, keep all records of rent payments to ensure all rental expenses you incur on behalf of your business can be properly accounted for. 

Salaries and benefits

Employee salaries such as wages and bonuses are tax deductible business expenses. Sole proprietors, partners, and LLC members are excluded from this meaning they cannot deduct any wages they pay themselves. In addition, employee benefit programs such as retirement plans and paid time off can be written off. 

Travel expenses

Most businesses plan and allocate resources for travel expenses in advance. As long as you travel for business purposes, flights, meals, hotels, and transportation are fully deductible. Every expense must be business related. Some examples include, but are not limited to attending a business meeting, seminar, or conference. 

8 Non-Deduction Expenses for Small Businesses

You should be aware that certain business expenses are not considered a tax deduction in order to steer clear from including them when you file. 

• Fines and penalties
• Entertainment
• Commuting costs
• Personal expenses/activities
• Political contributions
• Travel expenses for travel companions
• Gifts up to $25
• Club and Membership Dues

Fines and penalties

Any fees that you or your business have incurred can not be written off. Some common fines and penalties include late fees when filing federal and state tax returns, parking tickets, and safety violation fees. 

Entertainment

As of 2017, under the Tax Cuts and Jobs Act money spent on business related entertainment are non-deductible. Business entertainment or activities considered non-deductible are golf outings and sports events. 

Commuting Costs 

Commuting from home to the office and vice versa in your personal car is considered a non-deductible expense. Although, traveling to meet a client or other work related obligations during business hours can be deductible. The main difference between these two expenses is one is essential for business, whereas the other, in the eyes of the IRS is not necessary. 

Personal Expenses/Activities 

If the main purpose of this expense is not revolved around business, then it is considered non-deductible. For example, if the primary use of a cell phone is personal then it’s considered a personal expense and not a business expense. This applies to any hobbies or extracurricular activities that one may participate in. 

Political Contributions 

Although supporting a specific candidate or lobbying to change a law in your industry feels like you’re investing time and effort to benefit your business, this cost is not deductible. Any political contributions made will not be eligible as a tax write off. 

Travel Expenses for Travel Companions 

You may travel often for work and all work related expenses are deductible. However, if your spouse or a family member joins you on these trips, the expenses they incur are not deductible. This includes all flights, hotels, meals, and transportation that are purchased cannot be written off as they are not part of the business. 

Gifts up to $25 

Gifts for clients, employees or partners can only be deducted up to $25. So if a gift exceeds that price then it is not considered as a tax write off. Gifts that exceed this amount vary, but a couple examples are diamond bracelets or a smartwatch.

Club and Membership Dues 

While joining clubs could be beneficial for your business in terms of networking, this expense is not qualified as a tax deductible. This includes hotel membership clubs, country clubs, and other social clubs where networking may occur.

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