Tax Deductions for Small Businesses

The portion of any business that gets taxed is the net business profit. The net business profit is specified by subtracting the expenditure of doing business from the total gross income of the business.

Business expenses refer to the cost of carrying on a trade or business, and these expenses are typically deductible if the business operates to make profits.

What Are Tax Deductions?

Tax deductions are reductions of income that the government can tax. The goal of tax deductions is to reduce one’s taxable income, thus decreasing the amount of income tax that a taxpayer owes to the federal government. There are hundreds of ways to use deductions to lower your taxable income, but many individuals do not know about them or know how to take advantage of them.

How Do I Determine the Amount of Income Tax My Business Owes?

The income tax that a business owes will be based on various state and federal regulations and the kind of business structure chosen when the company was initially formed or registered. Each type of business organization is taxed differently.

What Types of Tax Deductions Are There?

There are two major types of tax deductions:

• Standard deductions
• Itemized deductions

The standard deduction is just that—a standard dollar amount set by the IRS each year.

Itemized deductions hinge on the amount being declared in each category. These deductions include:

• Casualty and theft losses
• Charitable contributions
• Medical and dental costs
• Union dues
• Home office expenses
• Gambling losses
• Interest paid on investments
• Property tax
• Personal property tax
• Job-related expenses

What Is Considered a Casualty or Theft Loss?

A casualty or theft loss occurs when you lose personal or business property due to a casualty, such as a fire, flood, tornado, or theft. If you have insurance for your damaged property, a deduction cannot be taken on your tax return unless you file an appropriate insurance claim for compensation. You must file a claim if you have insurance, even if you expect no compensation. Some casualty and theft losses are not tax-deductible.

How Do Charitable Contributions Work?

Provided you make a charitable contribution to a qualified organization, you can claim a tax deduction if you itemize your tax deductions on your tax return. Generally, you may deduct up to 50 percent of your adjusted gross income, but some cases apply 20 percent and 30 percent limitations.

For instance, contributions to particular private foundations, veterans’ organizations, fraternal societies, and cemetery organizations are limited to 30 percent adjusted gross income. The total tax deduction on your tax return cannot exceed half of your adjusted gross income. Any excess charitable contributions may be carried forward for five taxable years.

How Does Interest Qualify as a Tax Deduction?

To deduct interest on your tax return and thereby increase your potential tax refund, you must have paid off a debt and have been legally liable for the debt.

What Expenses are Deductible?

For a business expense to be deductible, it must be both ordinary and necessary. Ordinary expenses refer to common and accepted expenses in your trade or business. In contrast, necessary expenses refer to useful and appropriate expenses for your trade or business.

It is essential to mention that an expense does not have to be indispensable for it to be considered necessary.

Some examples of business expenses that are deductible are:

• Wages and Salaries: You can typically deduct the pay you give to your employees for the services they perform for your business.
• Rent Expenses: Rent refers to any amount you pay to use property that you do not own, and generally, you can deduct rent as an expense if the rent is for the property you use in your trade or business. Nevertheless, rent is not deductible if you have or will receive equity in or title to the property.
• Interest Expenses: Business interest expenses refer to the amount charged for using the money you borrowed for business activities.
• Insurance Expenses: You can generally deduct the ordinary and necessary insurance costs for your trade, business, or profession.
• Taxes: Federal, state, local and foreign taxes directly attributable to your trade or business can be deducted as business expenses.
• Retirement Plans: These are savings plans that offer you tax advantages so that you can set aside money for your retirement and your employees’ retirement.
• Advertising and Promotion: The price of advertising your business, such as through websites, business cards, yellow page ads, and other methods, are deductible as current expenses. Also, promotional costs which create business goodwill are deductible as long as there is a clear association between the sponsorship and your business.
• Books and Professional Fees: Business books are fully deductible, and fees that you pay to attorneys, tax professionals, or consultants can generally be deducted in the year incurred.

What About Your Home or Your Car?

If a part of your home is used for business objectives, you may be able to deduct costs related to the business use of your home.

These expenses can include:

• Mortgage interest;
• Insurance;
• Repairs;
• Depreciation; and
• Utilities

Also, if you use your car for business, you can deduct the car costs. Nevertheless, if you use your car for business and personal purposes, you must split your expenses based on the actual mileage.

What Are Other Types of Expenses?

It is necessary to distinguish business expenses from personal expenses, the cost of goods sold, and capital expenses.

• Personal Expenses: You normally cannot deduct personal, living, and family costs. But if you use something partially for business and partially for personal use, you can split the total price between the business and personal parts and deduct the business part.
• Cost of Goods Sold: You typically have to value inventory at the beginning and end of each tax year to specify your cost of goods sold if your business manufactures products or purchases them for resale. Some of your expenses may be included in calculating the cost of goods sold, and if you include an expense in the cost of goods sold, you cannot deduct it again as a business expense.
• Capital Expenses: You have to capitalize rather than deduct some costs. These costs, called capital expenses, are a part of your investment in your business. You capitalize on the three types of costs: business start-up costs, business assets, and improvements.

Should I Contact a Lawyer?

Tax laws can be complex and difficult to understand. If you are not sure how to do your business taxes or want to be sure that you are getting every benefit under current tax laws, it would be beneficial to talk to an accountant.

But, if you feel that you may have (or know you have) transgressed the tax law regarding small business deductions, then it is in your best interest to contact a local tax attorney today.

While it might be tempting to ignore it and hope that the IRS doesn’t catch your error, there are severe consequences for those committing tax evasion, especially for small business owners, who can be penalized severely under federal and state tax laws. Don’t risk a penalty from the IRS; use LegalMatch to start resolving your legal issues today.