Business Expense Deductions Lawyers

The IRS permits self-employed individuals and business owners to deduct expenses required to conduct their business from their taxes. The cost must be deemed ordinary, necessary, and reasonable to conduct business operations to be deductible. To be deductible, the expense must be common, useful, and accepted standard industry practice.

Which Business Expenses Can Be Deducted?

There are three categories of deductions accepted by the IRS: the cost of goods sold, capital expenses, and personal expenses needed to run the business. Items can be deducted only in one category. You cannot, for instance, claim the same expense as a capital business expense and a personal expense. To specify the costs of goods sold, the costs related to storage, labor, raw materials, factory costs should be included.

The following items are likely to be deductible for many taxpayers:

• Vehicle: If you have expenses related to a car needed to conduct business operations, the expense of the vehicle and resulting costs can occasionally be deducted as a business expense.
• Mileage: Mileage related to business travel can be deducted as a business expense.
• Home Office: There are precise regulations for what qualifies as a home office. It must be a separate room of your house in which business is routinely conducted and not used for any other purpose.
• Utility Bills: If your home office qualifies, you can often deduct portions of your utility bills. The formula uses the square footage of the overall residence as 100%. If your home office is, for example, 25% of the home’s square footage, you might be able to deduct 25% of related utility bills.
• Supplies: Office supplies are deductible as business expenditures.
• Equipment: Routine items such as staplers and pens can be deducted, as can computers, software, and printing devices.
• Cell phone: Cell phone bills and cell phones are deemed a legitimate business expense.
• Travel: Travel for a legitimate business purpose can be deducted, as can all related expenses.
• Meals: Meals bought during work trips and business travel can be deducted.
• Miscellaneous Deductions

Which Expenses Are Not Deductible?

Living expenses, charitable contributions, political contributions, property restoration or renovation, lobbying expenditures, government fines, or business dues paid to social clubs are not deductible as business expenses.

What Is the 20% Pass-Through Tax Deduction for Business Owners?

Under the Tax Cuts and Jobs Act, pass-through business entity owners can potentially deduct 20% of their business income.

The Tax Cuts and Jobs Act (TCJA), the enormous tax reform law in 2018, designated a new tax deduction for owners of pass-through businesses. Pass-through owners who qualify can deduct up to 20% of their net business income from their income taxes, lowering their effective income tax rate by 20%. This deduction began in 2018 and is planned to last through 2025—that is, it will end on January 1, 2026, unless extended by Congress.

This deduction can add up. For instance, if you have $100,000 in pass-through income, you could qualify to deduct $20,000, lowering your income taxes by a whopping $4,400 if you’re in the 22% income tax bracket. All small business owners need to comprehend this intricate deduction.

Pass-Through Business

You must have a pass-through business to qualify for this deduction.

A “pass-through business” is any business that is owned and managed through a pass-through business entity, which includes any business that is:

• A sole proprietorship (a one-owner business in which the owner privately owns all the business assets)
• A partnership
• An S corporation
• A limited liability company (LLC), or
• A limited liability partnership (LLP)

For tax purposes, what differentiates these businesses is that they pay no taxes themselves. Rather, the profits (or losses) from such businesses are passed through the business, and the owners pay tax on the money on their tax returns at their tax rates. The vast majority of smaller businesses are pass-through entities. Indeed, over 86% of businesses without workers are sole proprietorships.

Regular “C” corporations do not qualify for this deduction; nonetheless, they qualify for a low 21% corporate tax rate on all their income. Unlike the pass-through deduction, the 21% rate for C corporations is enduring under the TCJA.

Qualified Business Income

People who make income through pass-through businesses may qualify to deduct from their income tax an amount equal to up to 20% of their “qualified business income” (QBI) from each pass-through business they possess. (IRC Sec. 199A). QBI is the net income (profit) your pass-through business earns during the year. You subtract all your regular business deductions from your total business income.

QBI includes rental earnings so long as your rental activity qualifies as a business (as most do). It includes earnings from publicly traded partnerships, real estate investment trusts (REITs), and qualified cooperatives.

QBI does not include:

• Short-term or long-term capital gain or loss—for instance, a landlord would not incorporate capital gain earned from selling a rental property
• Dividend income
• Interest income
• Wages paid to S corporation shareholders
• Guaranteed payments to partners in partnerships or LLC members, or
• Business income earned outside the United States.

QBI is determined separately for each separate business you own. Suppose you own multiple businesses that are not service businesses listed below. In that circumstance, you have the possibility of integrating them into one for the deduction, but only if at least two of the following requirements are satisfied:

1. The businesses deliver products or services that are the same or customarily presented together, or
2. The businesses share facilities or meaningful centralized business components, such as personnel, accounting, legal, manufacturing, purchasing, human resources, or information technology resources, or
3. The businesses are employed in coordination with, or dependent upon, one or more businesses in the combined group.

If one or more of your respective businesses lose money, you deduct the loss from the QBI of your profitable businesses. If you have a qualified business loss, your net QBI is zero or less—you get no pass-through deduction for the year. Any loss is carried on to the next year and is deducted against your QBI for that year.

Example
This year, Greg earned $20,000 in QBI from his bitcoin mining company and had a $50,000 loss from his detached bakery business. He had a $30,000 qualified business loss, so he gets no pass-through deduction for the year. The $30,000 loss must be carried forward and deducted from his QBI in the next year or years.

Taxable Income

To specify your pass-through deduction, you must first calculate your total taxable income for the year (not counting the pass-through deduction). This is your total taxable earnings from all sources (business, investment, and job income) minus deductions, including the standard deduction ($12,550 for singles; $25,100 for married couples in 2021). You must have positive taxable income to take the pass-through deduction.

Moreover, the deduction can never exceed 20% of your taxable income.

Example
Lenny made $100,000 in profit from his consulting company in 2021. He had no other earnings and took the standard deduction. His taxable income is $87,450 ($100,000 – $12,550 standard deduction = $87,450).

Even though Lenny had $100,000 in QBI, his pass-through deduction cannot surpass 20% of $87,450, or $17,490. If Larry had $12,550 in additional nonbusiness revenue, he would have had $100,000 in taxable income and qualified for the full 20% of QBI deduction, or $20,000.

Do I Need a Lawyer?

Tax law is complex, and the penalties for incorrect reporting can be costly and even severe. A tax attorney can advise you of your best options in filing and addressing potential audit risks.