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Understanding Small Business Deductions
As tax season approaches, many small business owners are weighing what can be deducted on their tax returns and ensuring they're not leaving money on the table. Most people overthink and overstress on this topic. There is no right or wrong answer for each business, as long as you have proper documentation for the expenses you're claiming. Some deductions will be limited (or perhaps disallowed) by the tax code, but if your expenses are truly keeping your business active and profitable, in most cases they're going to be deductible.
Key Principles of Tax Deductions
When it comes to tax returns, there's an adage to keep in mind: "Pigs get fat, hogs get slaughtered." This means it's good to maximize tax deductions safely, maintaining a healthy flow of cash within your business without raising IRS red flags from overly aggressive deduction strategies.
- Profit Focus: Continual losses on a Schedule C can attract IRS attention. The IRS expects businesses to turn a profit within five years, distinguishing between genuine business ventures and hobbies.
- Bookkeeping is Crucial: Proper record-keeping is vital for capturing all allowable expenses. Whether using Excel, Wave, or QuickBooks, establishing a robust system will ensure nothing is missed.
What Can You Deduct?
The IRS doesn't provide a definitive list of deductions, which allows you to tailor expenses to fit your business's needs. Understanding "ordinary" and "necessary" expenses is crucial.
- Ordinary: These are common and accepted expenses in your industry.
- Necessary: These expenses are helpful and appropriate for your trade, even if not indispensable.
Examples of Common Deductions
- Advertising, including social media ads
- Bank and credit card fees
- Continuing education relevant to your current job
- Dues and subscriptions related to your business
- Employee-related costs, such as wages, insurance, mileage reimbursement, and payroll taxes
- Business insurance,
- Loan interest (not loan principal payments)
- Repairs and maintenance
- Materials and supplies
- Meals (properly documented)
- Mileage or other vehicle expenses
- Professional fees for your accountant or legal services
- Rent
- Telephone and internet (with appropriate personal/business allocation)
Home Office Deduction
This is often mistakenly avoided as taxpayers assume it will lead to an audit. The IRS encourages this deduction by providing simplified and actual expense methods for calculating totals. I'll highlight this in more detail in a future newsletter to ensure you're capturing this deduction to its full potential.
IRA Contributions
Decisions can be made until the tax return filing, including up to the extension deadline. If you extend your tax return until the October 15, 2025 deadline, you have until the date you submit your return to make a contribution for the prior year. Pretty cool tax planning and retirement savings opportunity if cash flows are tight in the beginning.
What You Can't Deduct
- Unless the clothing you're wearing is a uniform with your companyā€™s name and used solely for work, your clothing isn't deductible. If you can wear it out to dinner after work, it's not deductible.
- Gym memberships are not deductible if you're using the membership personally. Even if you are an online influencer, the tax courts have ruled that supplements and gym memberships are personal in nature and not deductible as a business expense. See Battle v. Commā€™r, T.C. Summary 2007-27; and Rev. Rul. 78-128. (However, if you meet with personal training clients at the gym, then you may be able to prorate that membership between personal and business-use.)
- Owner distributions and personal tax payments are also non-deductible. (If you are an S-Corporation, your salary as an employee would be deductible.)
- Meals that aren't specifically business related should not be run through the business as they're not deductible. Grabbing coffee in the morning or lunch in between job sites is a no-go for the IRS. And just costing you money in bookeeping and accounting fees when you pay for these with your business card.
Conclusion
I hope this overview helps clarify small business tax deductions. Always keep in mind what is "ordinary and necessary". Document thoroughly, stay informed, and I look forward to helping you navigate these waters in future newsletters!
Deductible Business Expenses - IRS Terminology
ORDINARY: One that is common and accepted in your industry
NECESSARY: One that is helpful and appropriate for your trade or business (An expense does not have to be indispensable to be considered necessary)
Resources
Cash flows are the fuel for a growing business. Don't let the tax tail wag the dog. It may actually make more sense to write a small check to the IRS than to write a large check (or take on an expensive loan) for an unnecessary piece of equipment. Focus on long-term cash flows and the money stressors will be kept at bay.
Don't Just Take My Word For It
Check out these links for up-to-date information directly from the IRS.
"If you buy things you do not need, soon you will have to sell things you need."
-Warren Buffet
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