Maximizing Business Expense Deductions
The IRS defines business expenses as those costs that are "ordinary and necessary" for the type of work performed. Knowing the difference between deductible and nondeductible business expenses is only part of the equation for tax purposes. It's also vital to accurately track expenses — ensuring that no legitimate small business tax deductions are missed when it comes time to prepare annual tax returns. Now, changes in tax rules introduced via the Tax Cuts and Jobs Act may affect what you can and cannot write off.
Let's take a quick look at how you can accurately claim business expenses for tax purposes.
How to claim business expenses on your taxes accurately
To deduct business expenses, you're required to properly substantiate them throughout the year in accordance with tax law requirements so you're prepared at tax time to claim all the small business tax deductions to which you're entitled.
Document deductible business expenses throughout the year
Proper documentation is one of the most important components of business expense reporting. Most business expenses are supported by receipts. These receipts should be maintained throughout the year and used as the basis for accounting records. Filing and organizing receipts can be time-consuming, but cloud accounting systems with scanning capabilities and preset forms may allow expenses to be captured as they're incurred. In a cloud system, additional details may also be entered to assist with proper account assignment.
In addition to receipts, other items like written logs may need to be maintained for expenses such as mileage deductions and business meals, so it's important to remind employees about IRS rules and regulations.
Categorize your business expense deductions properly
To avoid increased scrutiny, expenses should be categorized according to tax reporting requirements. The IRS requires business expenses to be differentiated from cost of goods sold, capital expenses, and personal expenses. Thus, not every cash outlay meets the criteria for a business expense. For example, office supplies are considered business expenses, while purchases of office equipment are often classified as assets and expensed over their entire useful life. Some equipment purchases may qualify for upfront deductions, such as the Section 179 deduction and the de minimis rule, which allow businesses to deduct the full cost of qualifying equipment or software purchases in the first year rather than requiring depreciation over the useful life of the item.
Schedule your deductible business expenses
Timing is another factor when claiming business expenses. When you can report deductible business expenses for tax purposes depends on your method of accounting. Most small businesses use the cash method, which allows expenses to be taken when paid. Expenses spanning more than one reporting period, such as long-term insurance policies, may need to be recognized over more than one tax period under the accrual method, which fixes the liability to a date. (According to the IRS, cash method taxpayers can usually deduct insurance premiums in the year paid.) For example, a cash method business deducts the rent when it's paid to the landlord, but an accrual basis business deducts it on the date it's due (in other words, the date the liability for payment is fixed), regardless of when the rent is paid.
Double-check your business expense calculations
Miscalculations and math errors may raise audit flags and should be avoided at all costs. When claiming business expenses, check your calculations for accuracy. Make sure that the proper mileage rate has been applied, as it is updated each year by the IRS. Any multi-step computations backing up a reported total should be supported by worksheets in the event of future questions.
Also apply proper limitations for certain expenses. For example, only 50 percent of business meals are deductible, and depreciation for expensive business vehicles are subject to dollar limitations each year.
Utilize accounting tools to record your deductible business expenses throughout the year
To increase tax reporting accuracy and efficiency, dedicate some time each month updating accounting records. The use of a cloud accounting system can help structure expense reporting and make year-end tax preparation less time-consuming. Apps can also be helpful in tracking business expenses and vehicle mileage, the information from which is then transferred to your accounting system.
Business expenses you may want to claim
Running a small business takes time, hard work, and money. To lessen the financial burden, there are a variety of small business tax deductions available to owners. Now that you're up to speed on how to track deductions all year, you'll want to make sure that you're aware of what you'll be claiming ahead of time. Some of these small business tax deductions may be familiar, while others may be new or often overlooked. Eligible owners searching for options to update their tax strategy may be able to take advantage of the following common small business tax breaks.
Cost of new equipment
Businesses that buy new equipment can claim all or some of these purchases as deductible business expenses up front. Three small business tax deduction options for writing off equipment costs include:
- First-year expensing deduction (up to $1,020,000 in 2019), which must be elected.
- 100 percent bonus depreciation, which applies automatically unless you elect not to use it.
- De minimis rule (up to $2,500 per item or invoice for small businesses), which must be elected to effectively treat equipment as materials and supplies and not as assets on the balance sheet.
A tax professional can help you decide the best option for your business.
Taxes paid on necessary purchases
Taxes themselves are often overlooked as tax-deductible business expenses. Deductible taxes include occupational taxes charged by a locality for the privilege of working or conducting business, personal property taxes imposed on personal property used in your trade or business, and real property taxes on any realty your business owns.
But you can't separately deduct sales tax. Any sales tax on a service or for the purchase of property is treated as part of the cost of the service or the property. So, if the cost of the service is deductible, effectively the sales tax becomes deductible as part of the cost of the service.
Home business expenses
If part of a home is used for business, a portion of home-related costs may also be eligible for a tax break. IRS Publication 587, Business Use of Your Home lists all eligible deductions, which include items such as business furniture and even depreciation of your home.
Employee healthcare premiums you cover
Health insurance premiums you pay for employees are deductible business expenses, even though not taxable to employees (and exempt from payroll taxes). S corporation owner-employees (those owning more than 2 percent) are taxed on employer-paid premiums but can claim a 100 percent deduction on their personal tax returns.
Small employers that obtain coverage for employees through the SHOP marketplace and pay at least half of the healthcare premiums for their staff may qualify for a 50 percent tax credit. The amount of the deduction for premiums is reduced by the amount of this credit.
Business hardware and software
New computer equipment and off-the-shelf software purchased for business use may be claimed as a legitimate tax break for small-business owners. For more details see IRS Publication 946, How to Depreciate Property. Custom-designed software costs usually must be capitalized and recovered through amortization over a number of years.
Advertising and promotion expenses
Advertising costs are also deductible business expenses. Everything from ads in local directories to the costs of maintaining an online business presence (via a website, social media accounts, etc.) may be eligible. In addition, if a business sponsors an event or sports team to promote goodwill, the cost may be deducted if there's evidence of a promotional effort.
Academic courses, training, and other educational activities that help contribute to the running and management of a business are eligible business expenses. But how employees are taxed on the education (and whether the cost is subject to payroll taxes) varies. For example, if courses are job-related, then the full cost is a tax-free fringe benefit to employees. But if the courses are not job-related and are paid under an educational assistance program, only the first $5,250 each year is tax-free to each employee.
If you think education and training courses may apply to your business, see IRS Publication 15-B. Employees can check on personal tax breaks for their education in IRS Publication 970, Tax Benefits for Education.
Mileage for travel using personal cars
If a business requires employees to use their personal vehicles for work, this can be a deductible business expense for the company that reimburses them. How employees treat the reimbursement depends on how it's done: under an accountable plan or under a nonaccountable plan.
Under an accountable plan, employees don't include reimbursements in income (and the company doesn't pay employment taxes on these amounts).
Under a nonaccountable plan, employees treat the reimbursements as additional compensation. But for 2018 through 2025, they cannot deduct the reimbursement as an itemized employee business expense.
Travel, meals, and gifts
Business trips, meal costs, and even some gifts may qualify as business expense deductions. Although travel and hotel costs are fully tax-deductible, only 50 percent of meal expenses are deductible in most cases. The deduction for business gifts is capped at $25 per recipient. And the cost of entertainment is a fully nondeductible business expense, even if business-related. To learn more about this sometimes complex category of allowable business expenses, see IRS Publication 463, Travel, Gift and Car Expenses.
The key to finding all eligible business expense deductions
Be sure to track deductible business expenses all year long, not just at tax time, so you don't overlook or underreport any legitimate business deduction. Help with your business finances is available online.