Expenses vary business by business and industry by industry. Each industry has widely accepted business expenses. Most businesses in the same industry will have similar expenses. A bank will have different expenses than a trucking company. A hotel will have different expenses than a grocery store. A home builder will have different expenses than a law office.
The IRS rulebook says: “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.”
When navigating them, use your judgment. You can ask 10 different CPAs the exact question and potentially get 10 different answers. To top it off, the IRS may see things differently as well.
Some business owners want to be aggressive with their small business tax deductions and are willing to take risks. Others want to be conservative. Then there are the people in between. When in a gray area, I tend to be conservative and err on the side of caution. I’d rather be at peace and sleep well at night. As songwriter Zac Brown says:
“There’s no dollar sign on a peace of mind, this I’ve come to know.”
Before we dig into some common small business tax deductions — here are a few more tips:
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Cost of Goods Sold and Inventory
Cost of goods sold is the cost incurred for products that are intended to sell. In the case of a manufacturer, this would be the cost incurred to create the products. Cost of goods sold is the cost of inventory. Tax Tip – inventory is expensed when sold, not when purchased. To expense inventory when purchased, elect to do so on form 3115.
Advertising and Marketing
Advertising and marketing is money spent to build your brand, message, and raise attention and awareness. Common examples are TV, social media, radio, and billboard ads and sponsorships.
Bank Charges and Merchant Fees
Some banks charge monthly fees for checking accounts and other services. In the digital age as we move to a paperless society, merchant services fees are common. These fees are the cost to receive payments electronically. Every time a customer swipes a debit or credit card or makes a payment, the business is charged a fee.
If your business has taken a loan for capital expenses such as purchasing a building, buying a van for deliveries, or buying equipment, you can deduct the interest paid on the loan.
Tax Tip – The business interest deduction limitation disallows all net business interest expense in excess of 30% of the adjusted taxable income of a business. Any amount subject to this limitation may be carried forward to a future tax year indefinitely until it is able to be applied.
Payments to Independent Contractors (1099)
If a business pays somebody for their services outside of payroll, that person is an independent contractor.
Tax Tip – Don’t fall into the trap of classifying those who should be employees as contractors to save a few dollars on payroll taxes The IRS and most states can audit your contractors and payroll to ensure your classifications are correct.
Wages Paid to Employees (W-2)
These are GROSS hourly wages and salaries paid to employees. If you only take distributions, these are not deductible
Tax Tip – S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee.
Legal and Professional Fees
Most businesses have an attorney and an accountant to help make informed business decisions. The amount you pay them for their professional services is deductible.
If a business owns a building, it can deduct the property insurance and personal liability insurance premiums.
If you own and operate a business, your health insurance is deductible. If your business pays health insurance premiums for employees, these costs are also a deductible expense.
Tax Tip – Health and accident insurance premiums paid on behalf of a greater than 2-percent S corporation shareholder-employee are deductible by the S corporation and reportable as wages on the shareholder-employee’s Form W-2, subject to income tax withholding.
Office Expenses and Supplies
Think about all of the paper, pens, paper clips, staples, and notebooks your business uses. Office expenses may also include software. These costs along with postage are deductible expenses.
These are small items used and consumed by a business. Supplies may include small tools, small pieces of equipment, janitorial products, coffee, cell phones, etc. Office expenses and supplies have some overlap and can get confusing.
Some office expenses and supplies may be categorized interchangeably. Categorize expenses to the best of your ability.
Rent or Lease
Do you rent or lease a building and equipment? If so, these costs are deductible.
Whether you own or lease property, your business utilities are deductible.
Employees cannot deduct a home office.
Business owners, as well as independent contractors (1099s), can claim the deduction if they use part of their abode for a home office.
The office must be used “regularly” and “exclusively” for business.
There is a restriction on deducting the approximate square footage of your home used for business and using that percentage in your calculations for how much rent or mortgage you can deduct.
Here’s how it works: Let’s say my apartment is 1,000 square feet, my office is 100 square feet, and I pay $1,000 a month for rent. My office is 10 percent of my apartment (100/1,000). I can deduct 10 percent of my rent, insurance, repairs, maintenance, and utilities.
If I owned a home, I could deduct 10 percent of my mortgage interest and real estate taxes.
Repairs, Maintenance, and Cleaning
Repairing, maintaining, and cleaning of buildings and equipment is deductible.
Real estate taxes, property taxes, and other business taxes are deductible. Real estate taxes are imposed on land and real estate. Property taxes are on things like cars and boats. Real estate and property taxes vary from state to state. Income taxes paid by the individual on business profits are not a deductible expense.
Business licenses and regulatory fees paid to the government and other professional organizations are deductible.
Travel for business purposes -including lodging and transportation is deductible.
Tax Tip – the cost of getting to and from your home and office is a non-deductible commuting expense.
Car and Truck
When a vehicle is used for business purposes, the IRS permits the business to deduct the cost of operating the vehicle in one of two ways:
Standard mileage rate: The standard mileage rate is 57.5 cents per mile in 2020. For every business mile driven, the business gets a deduction. For example, if a business owner drives 10,000 business miles, they’ll get a $5,750 deduction (10,000 x .575). This is the simpler method for business owners.
Actual expenses: This method is more complicated. This method requires the business owner to keep track of all business miles driven as well as receipts for all gas, oil, tires, repairs, insurance, maintenance, registration fees, and licenses. It also includes depreciation or lease payments.
Parking and Tolls
You can deduct parking fees and tolls if your business requires you to travel.
Business meals while traveling away from home are 50 percent deductible. Business meals also qualify for a 50 percent deduction.
Tax Tip – under various COVID tax bills – meal deduction expenses are changing. Go to IRS.GOV and search and meals and entertainment for the latest updates.
Depreciation is the process of expensing business property – like a computer – over time. Most small businesses can use ‘Section 179” depreciation which essentially allows a deduction in one year.
Tax Tip – Section 179 does come with limits – there are caps to the total amount written off ($1,040,000 for 2020), and limits to the total amount of the equipment purchased ($2,590,000 in 2020) so this makes it a true small and medium-sized business deduction.
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My Fiscal Office LLC
77 Bleecker Street
New York, NY 10012