“For every tax problem there is a solution which is straightforward, uncomplicated and wrong.” (Tax Advisor and Auditor Jokes)
As a small business owner, getting it wrong can be costly. Not least of all when it comes to understanding what business tax deductions you are eligible to claim.
Whether you prepare your own taxes or work with a tax professional, here is some basic guidance from the government that will help you take all the deductions that you deserve.
The Terminology: Business Expenses vs. Capital Expenses
Before you even start, knowing the difference between these two tax concepts is vital.
* Business expenses are expenses associated with the cost of doing business, e.g. property rental costs, business travel, and paying employees, etc. If you are a for-profit, these expenses are usually tax deductible. The IRS defines two requirements for a business expense, they must be both “ordinary” (i.e. common and accepted in your field) and “necessary” (i.e. an expense that is helpful and appropriate for your business).
* Capital expenses are the costs of purchasing specific assets, such as property and equipment and must be capitalized, rather than deducted as expenses. These assets are considered part of your investment in your business and may include start-up costs, business assets, and improvement costs.
Deducting Business Expenses
Below are the most typical types of business expenses that qualify for deductions.
* Personal vs. Business Expenses – Generally, you cannot deduct personal expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, such as a car, divide the total cost between the business and personal portions and deduct the business expense.
* Home-based Businesses – If you use part of your home for your business, you may be able to deduct expenses for items such as mortgage interest, insurance, utilities, repairs, and depreciation. Generally, deductions for a home office are based on the percentage of your home devoted to business use. For a full explanation of tax deductions for your home office refer to Business Use of Your Home (IRS Publication 587).Other business expenses include travel, meals, entertainment and gifts; employee pay; interest on loans; retirement plans; rent expenses; business taxes; insurance; and business-related education.
Deducting Capital Expenses
There are two ways to deduct capital expenses. You can “depreciate” them by deducting a portion of the total cost each year over an asset’s useful life; or you might be able to deduct the cost in one year as a Section 179 deduction.
Guidance and Support
If you are in doubt as to what qualifies as business expense versus a capital expense, consider taking advantage of online training or free tax training opportunities offered by the IRS. If you have hired an accountant, you should also seek his or her advice regarding tax deductions.
There are lots more one-stop-shop resources online, including this comprehensive Small Business Expenses and Deductions portal.
Alternatively, here are some direct links to clear and complete explanations of the following:
* Deducting business and capital expenses, visit Business Expenses (IRS Publication 535)
* Deducting the business use of your home, visit Business Use of Your Home (IRS Publication 587)
* Deducting travel and entertainment expenses, visit Travel, Entertainment, Gifts and Car Expenses (IRS Publication 463)
* Figuring out depreciation of capital assets, visit How to Depreciate Property (IRS Publication 946)