Deducting your business expenses
It costs a lot of money to run a business. But the good news is that the majority of these things you’ll need to purchase can also be used as deductions to offset your taxable income. Here are some of the most common ones to use.
Furniture and small equipment
Generally, anytime you purchase assets that will be used over several years, the IRS expects you to deduct these expenses by depreciating them in equal amounts over several years. However, that method can be somewhat complicated, and in recent years they’ve relaxed the rules for relatively smaller purchases.
For instance, if you bought furniture for your office or workspace, then you may be able to deduct the full purchase. Likewise, you can also do the same with small equipment. This is up to $5,000 per item in the year it was purchased.
Basic office supplies such as pens, paper, ink, etc. can all be taken as deductions in the year that they were purchased. (Technically, the IRS considers these to be consumable assets that will fully depreciate in under one year.)
Phone and internet service
These days, having a phone and the internet are critical to running a business. The IRS recognizes this, and just like your supplies, you can deduct the cost of your phone and internet service.
Remember that if you work from home or use your personal phone for work, then you are only allowed to deduct the percentage of the cost that applies for business purposes.
Your home office
If you work from home and have a dedicated space where you conduct your business, then it may qualify as a home office and serve as another tax deduction.
The IRS gives you two ways to value a home office deduction:
1. Actual expense option – To use this option, you’d need to calculate the total cost of all the expenses associated with your home (mortgage interest, taxes, maintenance and repairs, insurance, utilities, etc.) and then multiply this value by the percentage of your house that is devoted to your office space.
2. Simplified option – This is a relatively easier method where you simply multiply the square footage of your office space by $5 (up to 300 square feet).
Rental space and utilities
If you lease a space for your office or operations, then you can deduct the rent from your taxable income. Along the same lines, if you have utility bills to pay as part of this leased space, those are also considered deductible too.
As part of running your business, some financial purchases might also be considered to be tax-deductible. This would include things like:
• The cost of your business insurance
• Interest on bank loans
• Mortgage interest and real estate taxes (if you purchased property)
Private vehicle travel
Do you use your personal vehicle for work purposes? If so, then it may also qualify for a tax deduction.
Similar to a home office, the IRS will let you value your private vehicle expenses using one of two methods:
1. Actual Expenses method - Add up your expenses for the year (gas, insurance, depreciation, repairs) and multiply it by the percentage that applies to business use.
2. Standard Mileage method - Simply keep a record of the miles you traveled for business purposes, and multiply it by 57.5 cents per mile (may vary by year).
As you’re taking steps to promote your business, be sure to keep track of all your expenses related to this activity. For example, you may be able to fully deduct the following:
• Business cards
• Website design and maintenance
• Marketing brochures and flyers
If you meet with clients at a restaurant and pay for the meal, then it may also count as a tax deduction (up to 50 percent of the cost for food and drinks). The meal has to be solely related to business and properly documented to qualify.
Just like with your personal income taxes, anytime you donate money or goods to a qualifying organization, its value can also be considered as a taxable deduction.
Other strategies for reducing your taxes
In addition to tax credits and deductions, there are several other useful techniques for optimizing your tax bill.
Contribute to a retirement plan
As a small business owner, you are allowed to set up one of three types of retirement plans for yourself and your employees (if you have any):
• Solo 401k – Great for business owners with no employees (excluding spouses).
• SEP IRA – Ideal if you have one or more employees.
• SIMPLE IRA – For companies with 100 or fewer employees.
Most people don’t realize it, but retirement plan contributions can help your business in a big way.
First, as a business owner, you really wear two hats: The employer and the employee. And from the perspective of the IRS, you can contribute to your retirement plan from both sides. For example, with a SEP IRA, not only can you contribute up to $6,000 as an employee, but you can also contribute the lesser of 25 percent of your profits or $57,000 as the employer.
Second, every dollar that you contribute to your retirement plan or those of your employees will reduce your taxable business income. The lower the income you report to the IRS, the less taxes you’ll have to pay.
Be smart about deducting business equipment
As we mentioned earlier, for large purchases like equipment that you’ll need to conduct your business, the IRS will let you deduct its value over time (through depreciation) or deduct it as one lump sum depending on its cost.
Though both options will help you achieve the goal of reducing your taxes overall, there may be some advantages to choosing one method over the other. For instance:
• If your business is in its early stages and little to show for revenue, then taking the lump sum deduction wouldn’t be beneficial because there may be little or no profits to offset. In this case, it would be better to split the deductions over time through depreciation.
• If your business is more established and you’re making money, then depreciation wouldn’t be as beneficial towards offsetting your earnings. Therefore, it may be better to take as many lump sum deductions as you can.
Abandon property rather than sell it
Another little-known tax-savings opportunity is to abandon property rather than sell it. This might sound counter-intuitive, but because of the potential tax savings, it could end up resulting in a bigger net return.
The reason for this is because the IRS treats capital losses differently from ordinary losses. When you sell something at a loss, it's only deductible for up to $3,000. However, when you abandon it, then it's treated as an ordinary loss which is fully deductible for that year without any limit.
For example, if you were to produce lots of inventory for a product that sells poorly, then your first instinct might be to sell it at a low discount simply to earn any money at all. However, since there is no limit to how much you can claim for an ordinary loss, you might be better off to throw it away or donate it to charity thanks to overriding tax savings.
Hire a family member
Depending on the way your business is structured, hiring family members instead of people from the general public can be another useful way to reduce your taxes.
When you hire your spouse or children, their wages are exempt from FUTA (Federal Unemployment Tax Act) tax. Additionally, if your business is a sole proprietorship or a partnership with your spouse, wages to your children are also not subject to social security and Medicare taxes (as long as they are under 18 years of age).
Offer fringe benefits to employees
If you have employees, rather than give them a raise, it can help your taxes to compensate them with fringe benefits. These types of benefits would be free of tax and may include such things as:
• Employer-sponsored health insurance
• Long-term care insurance
• Group term life insurance
• Disability insurance
• Educational assistance
• Dependent care assistance
• Transportation benefits
• And many others
For a complete list, please see IRS Publication 15-B.
Change the structure of your business
Sometimes something as fundamental as how your business is set up can make a difference in your taxes. For instance, if your business is structured as an LLC or S corporation, then all of the income will pass through you, the owner, and be taxable. However, with a C corporation, the first $50,000 of your income would be taxed at a rate of 15 percent as opposed to a higher tax bracket.
Don’t forget about carryovers
If you’ve only applied some of your capital losses, operating losses, or charitable deductions in previous tax years, then the remaining portions may still be applicable. Therefore, don’t forget to carry them over into subsequent years for additional tax savings.
Best practices for reducing your taxes
While taking advantage of credits and deductions will undoubtedly save you a ton of money on your taxes, none of it will be possible unless you stay organized and up to date on your financial status.
The best way to do this is to keep receipts and documentation for every transaction you make. Additionally, be sure to do your book-keeping regularly. Definitely don’t save this task for the week before your taxes are due as this will not give you enough time to thoroughly optimize your expenses properly.
Above all, remember to always work with an experienced and reputable tax professional. Not only will they know the best tips and strategies to use, but they will also be up on all the latest legal changes from the IRS. Though you may be tempted to try to manage your taxes yourself, don’t be penny-wise and pound-foolish. Leave your taxes in the hands of the professionals so that you can focus on running and growing your business for years to come.
Disclaimer: Altruist or its affiliates do not provide tax advice and investors are encouraged to consult with their personal tax advisors. In no way should use of the word 'pro' be interpreted as providing potential investors any accreditation or level of sophistication.