15 Essential Business Tax Deductions
And how to maximize business tax deductions within IRS guidelines
|Written by Tom Yeung, CFA | CDFA|
Investment Advisor & Fund Manager, Jurnex Financial Advisors
In 2018, Congress passed the Tax Cuts and Jobs Act (TCJA), the single most significant overhaul in the tax code in 30 years. These changes reshaped the rules for business tax deductions.
Today, businesses and business owners alike must tread carefully with business tax deductions. That’s because the penalties for misfiling with the IRS can be steep. And while the IRS generally has three years to audit your tax returns, they reserve the right to audit up to 6 years if your return includes a “substantial understatement of income.”
In this article, we’ll cover the fifteen essential business tax deductions you can take without violating IRS rules.
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Special Business Tax Deductions
Unlike salaried workers, business owners have several unusual deductions available to them.
1. Qualified Business Income Deduction (QBI)
In 2018, Congress passed one of the most significant changes in tax-code history: the 20% Qualified Business Income Deduction (QBI). Under this new rule, businesses and sole proprietorships can deduct up to 20% of ALL qualified income from their trade or business.
In other words, a company that generated $100,000 of income would get to deduct $20,000 from its taxable income.
However, these new deductions come with specific rules.
- Phase-out rules. If your taxable income is between $157,500 and 207,500 ($315,000 and $415,000 if filing jointly), phase-out rules apply for certain service-related businesses
- Ineligibility rules. When any business meets set thresholds, they become ineligible for ANY business deduction. While Congress designed this rule to prevent large corporations from taking the QBI deduction, many small businesses can also find themselves left out.
A professional business tax accountant can help you determine whether you’re eligible for the QBI deduction
2. Rent Expense (And Home Office Deduction)
Business owners can deduct any rental expenses related to their business. Deductions even include rent on your home if you use it as a place of business. And if you work from home, you can also deduct up to $1,500 for home office expenses, based on $5 up to 300 square feet.
For long-term rents, in 2018, new IRS rules also exempted small businesses from Uniform Capitalization Rules (UNICAP). These changes mean small companies no longer have to worry about the non-deductibility of long-term rents (something large companies still need to deal with).
However, small businesses MUST still beware of deducting “unreasonable rent.” Typically, unreasonable rent issues arise when you rent from a related person, such as a family member.
3. Vehicle Expense
Starting in 2019, you can deduct a standard rate of 58 cents per mile for operating your car for business purposes. That means anytime you visit customers, suppliers, or prospects, every mile you drive can get deducted from your taxes.
Keep in mind this does not include commuting costs. Miles driven from your home to your work are considered personal expenses by the IRS.
Furthermore, instead of using the standard rate, you can also deduct actual expenses. In other words, you can pro-rate the ACTUAL cost of running and maintaining your car. This method can be beneficial for people who have larger vehicles that are more costly to run.
Note that the IRS requires any “fleet” of vehicles to use the actual deduction method. Fleets mean if you operate more than five vehicles for your work.
4. Organizational And Start-Up Costs
New businesses can elect to deduct up to $5,000 of start-up costs AND $5,000 of administrative expenses. Any remaining costs must be amortized, or deducted over future years.
- Start-up costs include any amount paid in connection with creating or investigating an active business. Expenses can also include initial training fees for yourself or employees.
- Organizational costs include the cost of creating a corporation or partnership, such as filing fees and legal fees.
You can generally deduct advertising expenses that are directly related to your business. Advertising can include any print, web, radio, or other material.
You can also deduct the cost of goodwill advertising. For example, advertising alongside a nonprofit organization, such as the Red Cross, can also be deducted.
Keep in mind that the IRS will examine the “reasonable” nature of the advertising expense. In other words, they may disallow expenses that seem excessive for your line of business.
6. Safe Harbor Election
While you generally must capitalize (not deduct) costs to acquire or produce tangible property in your business, the IRS allows a safe harbor election for “De Minimis” costs if you meet specific reporting requirements.
Businesses with an applicable financial statement can generally deduct any item costing less than $5,000 per invoice. Other companies can generally deduct items costing less than $2,500 per invoice.
For example, if your business bought five $1,000 laptops in a year, You can treat each computer as a separate expense and deduct the costs of all five computers for $1,000 each.
Business Tax Deductions For Ongoing Expenses
The second category of deductible business expenses includes current expenses. These are costs that companies generate that are both ordinary and necessary.
7. Cost Of Goods
Manufacturing firms can deduct their cost of goods sold. The cost of products not only includes the amount you paid for the raw materials. It also includes:
- Freight-in costs. The cost of shipping raw materials to your production plant.
- Storage costs. Warehousing and any other storage costs.
- Direct labor. The amount paid to employees to produce your goods.
- Factory overhead. Amounts required to maintain factory running conditions.
Keep in mind manufacturing can include any type of company that produces or resells goods. That means these rules can apply to restaurants, online resellers, and retail stores.
8. Employee’s Pay
As a business owner, you can deduct dollar amounts paid to employees or contractors if you have them. The IRS requires two tests:
- Reasonableness. Business owners can only deduct reasonable salaries. The rule prevents owners from over-paying a related party or family member to offset business expenses.
- Services Performed. Companies must pay workers for services performed. The rule prevents companies from paying shareholders an unreasonably high salary to avoid business taxes.
In 2018, the TCJA made employee achievement awards and specific fringe benefits tax-deductible.
9. Maintenance And Repairs
Business owners can deduct routine maintenance charges in the year they’re paid. For example, you can deduct repairs such as painting the exterior of your office or changing out the oil in business equipment.
Any amount of maintenance and repairs that improve the asset (such as adding a new bedroom in a rental property) cannot get deducted. Instead, it will add to the basis of the property. Adding to the basis will reduce capital gains taxes LATER once you sell the property.
As property wears down with time, you can deduct what’s known as depreciation. These costs represent the dollar amounts required to REPLACE the property. For example, if your business owns office space, you can generally deduct the value of the building over 39 years. The speed of deduction depends on the property type.
- Intangible property. Under Section 197 of the IRS code, intangible property such as trademarks, patents, licenses, and permits, must be depreciated (amortized) over 15 years.
- Residential real estate. Homes rented out for dwelling purposes should get depreciated over 27.5 years.
- Commercial real estate. Real estate with commercial purposes, such as offices, retail spaces, and factories get depreciated over 39 years.
- Special Bonus Depreciation. Starting in 2018, businesses can apply for a 100% special bonus depreciation for non-real-estate properties. Applicable assets include office equipment, furniture, production equipment, and any other business-related tools. These provisions begin to expire in 2023.
11. Business Bad Debts
If you cannot collect money owed to your business, you can treat that amount as a “business bad debt.” The IRS has special rules to deduct these uncollectible debts.
- Partly worthless debts. You can deduct portions of bad debts that become partly uncollectible. The deduction is limited to the amount you charge off your books during the year.
- Totally worthless debts. If the debt becomes completely valueless, you can deduct the entire amount minus any amount you had previously deducted.
If a debt becomes totally worthless, you have up to 7 years to claim the expense from when you filed, or up to 2 years from the date you paid the tax.
Business Tax Deductions For Annual Expenses
Companies can also deduct regular expenses incurred every year.
If you have loans from a bank, you can deduct the interest payments from your overall income. The business interest expense deduction is limited to 30% of your adjusted taxable income.
Keep in mind, however, that you cannot deduct interest on income tax or interest paid with funds borrowed from an original lender. In other words, you can’t deduct the same interest expense twice by creating a second loan to pay the first one.
You can deduct various federal, state, local, and foreign taxes from business income. The rule prevents double taxation on the same revenue.
If your company has employees, you must withhold various employment taxes, such as Medicare and Social Security (known as FICA and FUTA taxes). These dollar amounts are also deductible to the business.
14. Business Insurance
If your company pays for insurance, you can generally deduct premiums you pay. Insurance premiums can include accident insurance, liability insurance, malpractice insurance, vehicle insurance, and life insurance.
15. Health Insurance
Businesses are also able to deduct medical insurance costs for both their shareholders and employees.
- Employees. You can deduct costs associated with group health insurance to any employee that owns less than 2% of the company (in the case of S-Corps).
- Owners. >2% owners of S-Corps, partners of a partnership, and self-employed people can usually deduct health insurance on Schedule 1 of Form 1040
Given the number of potential business tax deductions, a tax accountant can help you save both time and money when it comes to filing taxes. Reach out to me, or a qualified business tax accountant today for more information.
Where to find more resources
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