It’s no secret that a small business owner’s plate is overflowing with responsibilities leaving little to no time to decipher the intricacies of tax codes. Many small business owners, unfortunately, struggle to maximize their tax deductions because they’re too engrossed in managing their company or may just be unaware of the latest opportunities. Each year brings fresh changes to small business tax deductions, making it even more critical that you stay informed.
What is a small-business tax deduction?
Small business tax deductions are expenses that the Internal Revenue Service (IRS) recognizes and allows you to subtract from your taxable income, ultimately helping to pay less in federal and state taxes. This can free up more of your hard-earned capital to be reinvested elsewhere in your business — whether that’s for growth, innovation, or simply ensuring a healthy cash flow.
How do business tax deductions work?
There are two ways to claim small business tax deductions: standard deductions and itemized deductions.
Standard deductions: The standard deduction is a fixed amount set by the IRS, which you can subtract from your taxable income without needing to specify every expense. It’s essentially a simplified way to do your taxes.
Itemized deductions: Itemized deductions involve listing, detailing, and proving all your qualifying expenses such as office supplies, travel, rent, and more. Small business owners can deduct the exact amount spent on these eligible items. Itemized deductions require more effort in recordkeeping and may be time-consuming. These records will be examined if the IRS audits your business.
The key difference between standard and itemized deductions is that the standard deduction is a set amount determined by the IRS and every business is entitled to it. However, it may not cover all your eligible expenses. The standard deduction is hassle-free, while itemized deductions provide you with the opportunity to claim the full amount of your eligible expenses. It’s important to evaluate which method works best for your business to make the most of those valuable small business tax deductions.
23 Small Business Tax Deductions You Can Claim
1. Startup and organizational costs
Start-up and organizational costs are considered capital expenses by the IRS, meaning they’re considered investments in the long-term success of your business venture. To make these costs more manageable for new business owners, the IRS allows you to deduct them over a few years through a process called amortization. This spreads out the expense, allowing more financial stability for your business when making these investments.
Examples of start-up expenses include:
- Legal fees
- Employee training
- Business travel
The cost of inventory, which is equal to the cost of goods sold, can be deducted from taxable income. This means if your business sells products, the cost of those products is considered an expense. This deduction helps reduce your tax bill because you’re only taxed on the money you make after accounting for the cost of the goods you sell. The cost of goods sold is made up of various expenses, including:
- Cost of inventory
- Labor costs
- Overhead costs
- Shipping and transportation costs
- Storage costs
- Raw materials and supplies
- Cost of packaging
Meticulous recordkeeping of your inventory will ensure financial accuracy when filing tax deductions. Properly managing your inventory will contribute to your business’s overall success in the long term.
3. Business Utilities
Utilities that can be tax-deductible for a small business typically include:
- Electricity bill
- Internet bill
- Water bill
- Gas bill
- Telephone bill
- Trash & recycling
- Heat & AC
- Security systems
- Property taxes
- Business licensing fees
It’s important to note that the ability to deduct these expenses depends on various factors such as the local tax laws and regulations.
Below you’ll find a few different types of insurance that can be deducted as business expenses:
- Fire insurance
- Theft insurance
- Flood insurance
- Disaster insurance
- Credit insurance
- Liability insurance
- Workers’ compensation insurance
- Car and other vehicle insurance
- Business interruption insurance
5. Business property rent
Deducting business property rent from taxes can be complex and it depends on various factors, including whether the property is rented from a third party or if the business operates from a home office. Here are some general guidelines for deducting business property rent from taxes:
Business property rent from a third party:
- The rent paid for the business property must be ordinary and necessary for the business, directly impacting operations.
- Maintain a formal lease agreement with the property owner that outlines the terms and conditions of the rental.
- Keep all records of rent payments, utilities, insurance, repairs, or any other expense related to the property.
Home office deduction:
- The space must used regularly and exclusively for business related tasks.
- IRS offers a simplified home office deduction method, allowing a standard deduction based on the square footage of your home office. The regular method requires more documentation but may yield a much larger deduction.
- Self-employed individuals can generally deduct home office expenses but may need to meet a very specific criteria and fill out Form 8829.
Tax laws and regulations are always changing and differ from state to state. Always refer to the latest IRS guidelines or consult with a tax expert to understand how they apply to your specific situation.
6. Rent and depreciation on business equipment
Small business owners can fully deduct lease costs for equipment and machinery as an essential part of their business operations. When it comes to owned equipment and machinery, the concept of depreciation plays a crucial role in recovering the costs of fixed or tangible assets over time.
Depreciation is a tax accounting method that recognizes that things lose value over time due to wear and tear or being outdated. Instead of taking the full cost of the expense right away, business owners can deduct a portion of that cost each year on their taxes until they’re accounted for the whole thing.
One way small business owners can claim depreciation is through Section 179 deduction, which is a tax provision in the U.S. tax code. Here’s how it works:
Immediate deduction: Section 179 allows small businesses to deduct the full cost of qualifying items in the year they are placed in service rather than it deduct over several years. This provides an immediate tax benefit, helping reduce taxable income.
Eligibility: To qualify for Section 179, the equipment or machinery must be purchased and used during the tax year. There are limits to the total deduction amount which can change from year to year based on new laws and regulations.
Deduction limits: There are annual deduction limits on the total amount that can be expensed. These limits can vary based on the total cost of the equipment.
Exclusions: Some types of properties are excluded from Section 179 so its important to verify the IRS guidelines or consult with a tax professional to determine which assets qualify.
7. Auto expenses
Deducting auto expenses for small business owners can be done by taking into account both business and personal use of a vehicle. The IRS provides two primary ways for deducting auto expenses: the standard mileage rate and actual expenses.
Standard mileage rate: The IRS sets a standard mileage rate for each tax year, which you can use to calculate your deduction. Keep a record of your business-related miles driven. This includes trips to meet clients, attend business meetings, or other work-related travel. At the end of the year, multiply total business miles by the IRS standard mileage rate to calculate your deduction. This rate takes into account various auto-related costs like gas, maintenance, and depreciation.
Actual expenses method: This method requires you to track and deduct the actual expenses incurred for the vehicle including fuel, maintenance, insurance, depreciation, and other related costs. Keep detailed records of all auto expenses including receipts and invoices. Then calculate the percentage of business use of the vehicle. The business use percentage can be determined by dividing the total business miles by the total miles driven throughout the year.
*You can find detailed information on auto expenses including examples and specific rules on the IRS website.
8. Advertising and marketing
Small businesses can deduct an array of advertising and marketing expenses to promote their business. These are some of the advertising and marketing deductibles:
- Business cards
- Digital and print display ads
- TV & radio commercials
- Flyers & billboards
- Social media ads
- Website design
- Pay-per-click (PPC)
- Promotional items
- Event costs
Even if the entire cost of advertising and marketing is not fully deductible, part of it may still be eligible for deduction.
9. Office supplies and furniture
Office supplies and equipment used for business purposes are generally deductible as long as they are used within the year of purchase. Here’s a list of some tax-deductible items:
- Office supplies: Items like paper, pens, notebooks, printers, staplers, and other supplies used exclusively for business are typically fully deductible in the year of purchase.
- Computers & software: Computers, laptops, and business-related software can also be deductible. While the entire cost may be deductible in the year of purchase, some software may need to be amortized or depreciated over time, so it’s important to understand the specific rules for software depreciation.
- Office furniture: Certain types of furniture may be eligible for a deduction if they are used for business purposes. This includes items like desks, chairs, and filing cabinets. However, not all office furniture can be deductible in the year of purchase. For expensive items, you may need to depreciate the cost over time.
10. Software subscription
Software subscriptions used for business purposes are usually tax-deductible as ordinary or necessary business expenses. These expenses can be claimed on your tax return under the category of “Other Common Business Expenses” or “Other Miscellaneous Expenses” if you are filing a Schedule C tax form (used by sole proprietors and self-employed individuals).
Keeping well-organized receipts will help you easily identify and categorize these expenses when it’s time to prepare for tax season. Always adhere to tax regulations when claiming deductions. Consult with a tax professional or accountant if you have any questions regarding the deductibility of a specific software subscription or how to properly report them on your tax return.
11. Business entertainment
The rules and regulations regarding business entertainment tax deductions can be somewhat complex. Here’s an overview of key points to keep in mind:
50% deduction for most business meals: This includes meal costs with clients, business partners, or employees, as long as the primary purpose of the meal is business-related.
100% deduction for office parties: Office parties and similar social events held for the benefit of employees are generally 100% deductible. This can include holiday parties, picnics, and other events aimed at improving company culture and fostering a positive work environment.
Entertainment expenses: Expenses related to entertaining clients and associates may be partially deductible. This includes sports events, concerts, golf outings, or other similar activities.
Maintain detailed records of these deductible expenses including receipts and documents that specify the business purpose for each event or meal. The IRS may require proof in the event of an audit.
12. Travel expenses
Deducting travel expenses can be a bit complex and there are special considerations to keep in mind. The IRS’s official website states that travel expenses must be ordinary and necessary to qualify as a business travel deduction. Business travel and accommodation cannot be “lavish, extravagant or for personal purposes.”
Travel expense examples that may be deductible include:
- Plane, train, bus or gas fare for transportation
- Shipping costs for baggage
- Business calls
- Meals and tips
The rules for deducting domestic travel expenses differ from those for international travel. There may be specific rules and limitations for foreign business travel.
13. Interest Payments
Interest payments on small business loans and mortgages can be tax-deductible under certain conditions. Here’s an explanation of the deductibility:
Business expenses: Interest payments are fully tax-deductible if the loan proceeds are used to cover business expenses. This includes loans for expansion, equipment purchase, or financing day-to-day operations.
True debtor-creditor relationship: There must be a genuine debtor-creditor relationship between you and a traditional lender for interest to be deductible. In other words, the loan should follow standard lending terms and documentation and the lender should be a recognized financial institution.
Deductible amount: The Tax Cuts and Jobs Act (TCJA) passed in 2017 introduced changed in the deductibility of business interest expense. Under TCJA, the deduction is limited to 30% of your adjusted taxable income.
14. Bad debt
In small business taxes, the concept of “bad debt” refers to money a business expected to receive but could not because a customer, client, supplier, distributor, or employee failed to pay. This debt becomes uncollectible and can be claimed under as a deduction under certain conditions. If your business guarantees loans for other businesses or individuals, and they default on the loan, the guarantee amount may be considered a bad debt.
To claim a bad debt, you must prove that you had valid debt, meaning there was an enforceable obligation to pay. This can be documentation like invoices, promissory notes, or loan agreements. You’ll also be required to show proof of making efforts to collect the debt. This may involve sending collection letters, making phone calls, or taking legal action.
Federal income tax, state and local taxes, real estate taxes, as well as, sales taxes (in certain cases), personal property taxes, and specific employer taxes are generally deductible taxes on your federal income tax return. Self-employment taxes, franchise taxes, excise taxes, and occupational taxes can also be deductible. Small business tax deductions can vary depending on individual circumstances and the specific tax laws of your jurisdiction.
16. Employee salaries
Employee salaries are typically tax-deductible business expenses. This includes regular wages, bonuses, and other forms of compensation. When you hire contract labor or freelancers, it can also be tax-deductible. These payments are usually reported on Form 1099-NEC. However, sole proprietors, partners, and LLC members cannot deduct wages they pay themselves.
17. Employee benefits programs
Employee benefits programs are designed to boost employee satisfaction and overall well-being. Luckily for small businesses, this can serve as a valuable source of tax deductions.
Benefits that qualify for deductions include:
- Retirement plans
- Paid time off
- Education assistance
- Childcare assistance
- Life and disability insurance
- Dependent care assistance
Contributions to retirement plans for both employees and self-employed business owners can be claimed as personal deductions.
18. Employee gifts
According to IRS Publication 463, employee gifts are 100% deductible, up to a maximum of $25 per year per employee. This deduction specifically applies to tangible gifts and not entertainment expenses.
For example, sending a gift basket to an employee who recently had a baby or providing a client with a thank-you gift are both eligible for this deduction as they are tangible items. However, expenses related to entertainment like taking a client out to dinner, fall into a different category with its own tax rules.
19. Contracted labor
Business deductions include the costs of hiring freelancers or any contracted labor from their taxable income. Be sure to keep accurate records of all payments made to the contractor including invoices, receipts, and any relevant contracts or agreements. If you pay a freelancer or independent contractor $600 or more during the tax year, you are required to issue them a Form 1099-NEC (Nonemployee Compensation). A copy of this form must also be sent to the IRS.
20. Legal and professional fees
Fees paid to attorneys and accountants can be fully deducted as business expenses if they are related to business operations. These deductions can significantly reduce the business’s taxable income. Here are some examples of professional services that can be deducted:
Legal services: Fees paid to attorneys for legal tasks like drafting contracts, agreements, and handling litigation related to the business.
Accounting services: Fees paid to accountants for services like financial audits, bookkeeping, tax preparation, and financial consulting.
Due diligence reviews: Costs associated with hiring professionals for due diligence reviews, especially when buying or merging businesses.
21. Phone and Internet Expenses
Phone and internet expenses can be deductive for businesses if they are considered an integral part of the day-to-day operations. Here’s how you can deduct these expenses:
Internet service: If your business relies on the internet for regular operations such as email communication, research, or online sales, the costs associated with internet service can be eligible for deductions. This includes both monthly service fees and any additional costs like equipment rental or installation.
Phone service: The costs related to your business phone including landlines or mobile are deductible when used for business purposes. This includes service fees, long-distance calls, and the purchase of phones or related equipment.
In-flight internet: When traveling for business, the expenses for inflight internet services like WiFi on airplanes can also be deductible.
22. Charitable Contributions
Small businesses can deduct various types of charitable contributions such as cash donations, property donations, services, or sponsorships. The eligibility criteria for deducting charitable donations are subject to specific rules and limitations. These are the key points:
- Donations must be made to qualified, tax-exempt organizations recognized by the IRS, typically under section 501(c)(3).
- Maintain detailed records or written acknowledgments from the recipient.
- The amount of charitable contributions that can be deducted is generally limited to a percentage of your business’s adjusted gross income (AGI). The typical limit for cash donations is up to 60% of AGI. For property or services, different percentage limits apply.
- The rules and limitations for deducting charitable contributions can vary based on your business’s legal structure such as sole proprietorship, partnership, corporation, or S corporation.
- Follow IRS guidelines such as filling out Form 8283 for non-cash contributions over $500.
It is best to consult with a tax professional or accountant for guidance as the rules and limitations for charitable deductions can be complex and subject to change.
23. Energy Efficiency Expenses
Small business owners can potentially deduct various energy-efficiency expenses to reduce their tax liability. To qualify for the full deduction, a small business must demonstrate a 50% reduction in energy and power costs.
Some types of upgrades and improvements that may qualify for a deduction include:
- Lighting upgrade: replacing tradition fluorescent bulbs with energy-efficient LED can be deductible
- HVAC improvement: upgrading heating, ventilation, and air conditioning systems with energy-efficient systems
- Solar power: installing solar panels for renewable energy.
What Can Be Written off as Business Expenses?
Business expenses that can be written off for tax purposes include:
- Advertising: Costs associated with promoting your business.
- Office supplies: Expenses for items like stationery, paper, and pens.
- Rent: Payment for office space or storage.
- Utilities: Bills for services like electricity, water and internet.
- Travel: Expenses related to business trips like accommodation and plane ticket.
- Meals: Costs for business-related meals for employees and clients.
- Insurance: Premiums for required business insurance like liability or property insurance.
- Wages: Employee compensation including salaries and bonuses.
- Depreciation: The gradual decrease in value of assets over time.
- Professional services fees: Payments to attorneys, accountants, or consultants.
- Taxes: Business related taxes such as payroll or property.
According to IRS guidelines, expenses must be considered “ordinary” and “necessary” to be deductible. “Ordinary” means that the expense is common in the industry while necessary means the expense is helpful and required for your business operations.
Can you write off previous years’ taxes?
Small businesses usually cannot write off previous years’ taxes because the federal income tax is based on the annual income and expenses in a specific year. There are however a few exceptions to this:
Net Operating Loss (NOL) carrybacks & carry forwards: If a small business experiences a net operating loss in a given tax year, they may be able to carry back the NOL to offset income in previous tax years or the NOL be carried forward to offset future income for up to 20 years. There are many restrictions and limitations. Consult with a tax professional or CPA.
Amending prior year returns: If a small business discovers errors on previous tax returns, they can file an amended return (Form 1040-X) within a given timeframe to correct these answers.
How to claim small-business tax deductions
Claiming small business tax deductions and reporting taxable profit involves maintaining precise records, identifying the business’s legal structure, and accurately completing tax forms like Schedule C and Form 1040. This process ensures compliance with tax laws and helps maximize eligible deductions. For peace of mind and expert guidance, consider enlisting the help of a tax professional. Their expertise will simplify the complexities of tax reporting.