Tax Write Offs for Small Business: Maximize Your Savings This Year

Running a small business can be tough yet fulfilling! As a business owner, you get to chase your passion and build something that’s truly yours.

Along with that freedom, you’ve gotta handle your finances and figure out how to save more. If you’re new to the world of entrepreneurship, tax write-offs are your best friend.

So, let’s dive in and see how you can maximize your savings this year!

Disclaimer:I’m not a tax consultant, but I’ve been handling my small business taxes since 2018. Working with a bookkeeper and accountant has taught me how to manage my business expenses and figure out my tax deductions.

What are Tax Write-Offs?

Tax write offs, also known as deductions, are expenses that are considered eligible by the Internal Revenue Service (IRS) for reducing your taxable income.

This means that the more deductions you have, the less income you’ll be taxed on. For small businesses, this can make a huge difference in their bottom line.

Note: The IRS provides a Tax Guide for Small Business, which you can read here.

What Qualifies as a Write-Off?

A write-off is like a magic trick for your taxes. It’s an expense you can subtract from your total revenue to lower how much you pay in taxes.

To qualify, the expense needs to be something ordinary (common in your line of work) and necessary (fitting for your business).

Let’s dive into a few examples of deductible expenses:

• Office Supplies: Paper, pens, and other consumables
• Utilities: Electricity, water, internet, if used for business
• Home Office: A portion of your rent or mortgage, if exclusively used for business
• Equipment: Computers, furniture, and machinery (up to a full cost in some cases)

Differentiating Between Deductions and Credits

Deductions lower your taxable income, while tax credits reduce your actual tax bill, dollar-for-dollar. Take this for example:

• A $1,000 deduction, assuming you’re in the 20% tax bracket, saves you $200 in taxes (0.20 * $1,000).
• A $1,000 tax credit directly cuts your tax bill by $1,000.

The good news is you can claim both deductions and credits to maximize your tax savings.

Types of Business Expenses

Capital Expenses

Capital expenses are costs for long-term assets such as buildings, equipment, and land. These costs are not deducted in one year; instead, you recover them over time through a process called depreciation.

As an example, let’s say you purchase a new computer for $5,000. You can’t deduct the full cost in one year, but instead create a depreciation schedule to deduct a portion of the cost each year over the computer’s useful life.

Non-Capital Expenses

Non-capital expenses are costs that you can deduct in the year they occur. These include:

• Advertising: Costs for promoting your business, such as newspapers or internet ads.
• Travel and Meals: Expenses incurred while traveling for business purposes (excluding vacations) and meals associated with conducting business.
• Insurance: Premiums paid to protect your business assets or liabilities.

Operating Expenses

Operating expenses are everyday costs that keep your business running, such as rent, utilities, and supplies. These expenses can be deducted in full in the same year they were incurred.

Personal Versus Business Expenses

When it comes to personal versus business expenses, things can get a little tricky. As a general rule, expenses that are used solely for your business can be deducted in full. However, if the expense is used for both personal and business purposes, you can only deduct the portion that was used for business.

For example, if you use your home internet connection 50% of the time for business and 50% of the time for personal use, you can only deduct 50% of the expense.

Common Tax Deductions for Small Businesses

Getting through tax season is easier when you know about the deductions you can claim as a small business. These write-offs can really help reduce your tax bill.

Home Office Expenses

Your home office allows you to deduct a portion of your household expenses. If you use 20% of your home just for business, you could potentially deduct 20% of your rent, utilities, and maintenance costs.

Office Supplies and Equipment

Each pen, paperclip, or tool may seem small, but they all count. You can deduct the cost of supplies crucial for your business.

For big buys like computers and furniture, you can go for bonus depreciation to write off 100% of the cost in the year you buy them.

Travel and Vehicle Costs

When you’re traveling for work, you can deduct expenses like hotels, airfare, and meals. If you use your own vehicle, you have the option to claim the standard mileage rate or your actual expenses.

Just a heads-up, there are limits on depreciation deductions for passenger vehicles, capping at $10,100 in the first year without bonus depreciation.

Meals and Entertainment

Business meals can be partially deductible, but only up to 50% of the cost. If you take a client out for dinner to discuss business matters, you can write off half the bill as long as it’s not lavish or extravagant.

Don’t forget to hang onto ALL your meal receipts when you’re on the go. They’re important for claiming this deduction. The IRS lets you deduct the whole cost, so it’s a win if you travel or dine out with clients!

Contract Labor

Contract labor costs can be deducted as long as you keep records of the payments and have contracts in place. This includes hiring freelancers, consultants, and other independent contractors to complete tasks for your business.

If you’re self-employed and shelled out $600 or more to an independent contractor, you’ll need to fill out Form 1099-NEC to report those payments.

Legal and Professional Services

Professional services, like accountants and attorneys, are fully deductible if they help with your business. Just remember to keep personal and business expenses separate, just like all your other business costs. For instance, if you hire a tax preparer for both your business and personal taxes, make sure to keep the costs separate.

Note: My accountant and bookkeeper send me invoices, and I pay them directly from my business checking account. But when it comes to estimated tax payments, I handle those through my personal checking account.

How to Maximize Deductions

When it’s about tax deductions for your small business, the secret to saving more boils down to two things: making sure your records are spot-on and planning when to spend your money wisely.

Keeping Accurate Records

Keeping good records is key for tax deductions. The IRS needs proof for all deductions claimed, so having well-organized records is super important. Set up a system, whether digital or physical, to track all business expenses throughout the year. Here’s what to focus on:

• Receipts: Don’t overlook small purchases; they add up.
• Bank Statements: These can corroborate your receipts.
• Invoices and Bills: Keep them sorted by date and category.
• Mileage Logs: If you’re claiming vehicle expenses, detailed logs are a must.

Timing of Expenses

Playing it smart with when you spend your money can really make a difference in how much tax you end up paying. If you’re expecting more income this year, try to pay for necessary things sooner to balance it out.

And if next year seems like it’ll be a better year money-wise, think about holding off on some expenses. Here’s a quick guide on timing:

• Prepay Expenses: Pay for next year’s expenses now, if it means lowering your current year’s taxable income.
• Defer Income: If possible, push some income into the next year to keep this year’s income lower.

Specific Scenarios for Write-Offs

In your business journey, it’s key to remember that not all expenses are the same. Let’s dive into how certain costs can help lower your tax bill.

Startup Costs

Understand that the IRS views startup costs as capital expenses. You’re allowed to deduct up to $5,000 in startup costs in the first year of business. This covers market research, travel expenses to secure potential distributors, training for your employees, and legal advice on creating a business structure.

If you’ve spent more, the excess is amortized over 15 years. Here’s a quick breakdown:

• Research Expenses: Surveys, analyses, etc.
• Travel Costs: Flights and accommodations for business setup.
• Employee Training: Onboarding and initial training programs.
• Legal Fees: Business formation and consultancy.

Employee Benefits and Payroll

You might be stoked to find out that the expenses related to employee benefits and payroll are also tax-deductible. Salaries, wages, bonuses, commissions, and taxable fringe benefits can diminish your taxable income.

• Salaries and Wages: The bread and butter of your payroll deductions. Keep it reasonable.
• Bonuses & Commissions: As long as they’re paid out, they’re fair game.

Audit Triggers and Avoidance

To steer clear of any red flags that might trigger an audit, make sure your deductions are solid and can hold up under scrutiny. If your reported income doesn’t align with your spending, that could raise some eyebrows.

Here are a few things you can do to stay ahead of any issues:

• Disproportionate Write-Offs: Keep write-offs proportional to your income. Large deductions that seem excessive compared to your reported revenue might signal a red flag to the IRS.
• Mixing Personal and Business Expenses: Always separate personal expenses from business expenditures to avoid confusion and maintain clear records.

When claiming deductions, accuracy is your ally. Avoid guesswork by always cross-referencing your claims with the latest IRS tax code or consult with a tax professional. When it comes to deductions, it’s better to be safe than sorry!