Tracking revenue and getting paid with accounting software is a piece of cake, right? But what about finding your business’ bottom line… and calculating what you owe Uncle Sam?
In a small business, maximizing your tax deductions is critical to generating a healthy bottom line. Some deductions are obvious – rent, phone, cost of goods, salaries – but many small businesses might be leaving money on the table by not writing off everything available under the U.S. tax code. Here’s a small business tax deduction checklist to help you out
1. How To Get 35% Off Your Next MacBook
Section 179 is a great small business tax deduction, designed to allow businesses that purchase qualifying property during the year to fully write off the purchase price rather than depreciate over time. The value? The Section 179 deduction makes investing in new equipment more attractive since it reduces the effective purchase price. For an illustration of how this works, see the example below.
What qualifies as Section 179 property? Business equipment, computers, office furniture, publically-available software, vehicles over 6,000 lbs.
- Can only expense up to $500,000 in one year
- Property must be purchased and put into use by 12/31 of that year
- If total qualifying purchases exceed $2 million, then deduction is reduced dollar-for-dollar up to $2.5 million
- 50% “bonus depreciation” in first year on remaining balance if over $500,000 limit
Example: Danielle started a marketing consulting business during the year. For her small team of 6, she outfitted her new office with desks, chairs, computers, and in the break room even installed an espresso machine, air hockey table, and couches. The total cost was $90,000 and all purchases were delivered and installed during the year. Danielle is able to deduct the entire $90,000 purchase on her Year 1 tax return rather than the first year’s depreciation under Section 179. Assuming Danielle’s tax rate is 35%, she effectively saves $31,500 on her new office equipment.
2. Business Insurance
Insurance premiums related to your business are generally fully deductible. If you provide healthcare benefits to your employees as a small business owner, those are subject to other limitations not discussed here.
Certain insurance premiums are not deductible, including: life insurance where you are directly or indirectly the beneficiary, life insurance to secure a loan, and loss of earnings or disability insurance.
Generally, insurance premiums are deductible in the year they apply. In other words, if you pre-pay for a policy that covers you in multiple tax years, your premiums will only be deductible during the year of coverage (i.e. 2016 premium deducted in 2016, 2017 premium in 2017, etc.).
Example: Joe recently began operating a consulting business from his RV. He bought errors and omission insurance as well as general liability insurance to cover himself in the event of a lawsuit. These premiums would be full deductible in the year they were paid.
3. State & Local Taxes
State and local taxes are generally imposed in the jurisdiction you do business in. The state and local taxes your small business pays are generally fully deductible on your federal tax return. Note that you can never deduct federal income tax as a business expense.
Example: Sarah is a sole proprietor photographer from New York City who covers the fashion world. Sarah physically does business in New York and Los Angeles each for six months out of the year. Even though Sarah lives in NYC, she will owe tax in both California and New York for the portion of her income earned while she was working in each state. The good news is when Sarah prepares her federal income tax return, if she chooses to itemize her deductions she will be able to deduct the state income taxes she paid to New York and California on line 5a of her Schedule A.
Do you pay to commissions to sales employees or third-parties? These are 100% deductible expenses.
Commissions are frequently paid in the industries of real estate and consumer goods.
Example: ABC Supplements, LLC is a small business that sells energy mix and protein powder to fitness enthusiasts. They negotiated an affiliate marketing deal with Jack Smith to promote their products. Mr. Smith receives a fixed payment for every supplement that’s sold using his unique affiliate code. ABC paid Mr. Smith $24,000 during the year for affiliate sales. ABC would be able to deduct the entire amount of affiliate payments as a business expense.
5. Meals & Entertainment
As a business owner if you entertain your customers, clients, or employees the cost of your meals may be deductible as a business expense, as long as the meal was directly related to or associated with your business. Generally, the deduction for business meals is limited to 50% of the total cost – including tax and tip – however, there are certain circumstances where your meals could even be 100% deductible.
The 50% rule applies if the meal is directly related to business. Meals to discuss things like projects, financial results, and partnerships all fall under the 50% category. However, the IRS disallows a deduction for “extravagant or lavish” meals. There’s no specific dollar value to define “extravagant or lavish”, rather, the IRS leaves it up to a reasonable person’s interpretation. Safe to say, discussing weekly tasks with your business partner over a seven-course meal at the nicest restaurant in town would likely not be permitted.
Meal and entertainment costs are fully deductible when you provide them for the benefit of your employees in your office or place of business. Examples of this might be buying the team lunch, providing free coffee and snacks on-site, or a company party at the office.
Example: Mary is a web designer and developer who also monitors and regularly maintains her client’s websites. She has two employees. They are working on a big project and have to work late into the night. Because they all work remotely and Mary wants to make sure her amazing employees are well fed as they work into the night, she has dinner delivered to them. When Mary is ready to file taxes, she would be able to deduct 100% of the cost of these dinners since they are to her benefit.
Now you should have a better understanding of what expenses you can deduct from your profit. With the deduction examples above, small business owners can be empowered to maximize deductible expenses and minimize their tax bill.
What burning question would you like answered related to small business deductions?