Taxes, taxes, taxes… whether or not we like it, we’re obligated to pay them. It’s like a football game: We are all on the same playing field and follow (or should!) the same rulebook. As with a sport, it’s our responsibility to know what the rules permit and play the game to the best of our ability.
Then, of course, there is the referee. In this case — the Internal Revenue Service — who has the playbook and depending on who you get, may see things exactly as you do, or slightly differently.
We overthink taxes. For the vast majority of us, taxation is straightforward. Don’t get me wrong, there are people and businesses with sophisticated, intricate tax situations, which require a lot of work, care, time, planning, and attention. But those are the exception, not the rule.
Let’s focus on the vast majority of us. When small business owners ask me what expenditures they can seek a tax deduction for, I start the conversation by saying “anything you use for your business.”
Ask yourself if the purchase is a service, office space, or supply used for my business.
If the answer is yes, it’s a business expense and it is deductible. If not, it’s not deductible. That’s common sense, right? That’s my hot take.
When consulting with clients and talking with others, I refer to IRS language. I often mention the phrase ordinary and necessary. Ask yourself: “Is the cost ‘ordinary and necessary’ to operate your business?” If so, you can deduct it. And in case you are concerned you don’t know what the IRS considers ordinary and necessary, I have listed out deductions to consider.
The IRS rulebook says: “To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business.”
Outside of this we are given some leeway. For a full list of business deductions, the IRS provides an overview.
Many people believe that there is a secret or complex financial formula. They think others know something that they don’t. I don’t want to be the bearer of bad news, but there’s not. Don’t shoot the messenger.
Most small business tax deductions are as clear as the black and white of a referee’s jersey. But there are some gray areas.
When navigating them, use your judgment. You can ask 10 different CPAs the exact question and potentially get 10 different answers. To top it off, the IRS may see things differently as well.
Some business owners want to be aggressive with their small business tax deductions and are willing to take risks. Others want to be conservative. Then there are the people in between. Just like different athletes vary in tolerance and willingness to take risks, it’s the same with business people. What are you comfortable with?
When in a gray area, I tend to be conservative and err on the side of caution. I’d rather be at peace and sleep well at night. As songwriter Zac Brown says: “There’s no dollar sign on a peace of mind, this I’ve come to know.”
A business owner should know what tax form to file with the IRS. For example, a sole proprietor or single-member LLC files a Schedule C. They should review the form, get comfortable with it, or at least have questions to ask. The form will point out the most common small business tax deduction categories. The IRS forms also come with instructions.
If you are a business owner, I highly recommend reading your respective tax forms, and staying up-to-date with tax news.
Before we dig into some common small business tax deductions — here are a few more tips:
- Keep complete, accurate, and up-to-date records.
- Save all of your receipts and invoices.
- Keep a mileage log.
With that, here are some common business expenses:
1. Cost of Goods Sold
Cost of goods sold is the cost incurred for products that are intended to sell. In the case of a manufacturer, this would be the cost incurred to create the products. Cost of goods sold is the cost of inventory.
2. Advertising and Marketing
Advertising and marketing is money spent to build your brand, message, and raise attention and awareness. Common examples are TV, social media, radio, and billboard ads and sponsorships.
3. Bank Charges and Merchant Fees
Some banks charge monthly fees for checking accounts and other services. In the digital age as we move to a paperless society, merchant services fees are common. These fees are the cost to receive payments electronically. Every time a customer swipes a debit or credit card or makes a payment, the business is charged a fee. These fees — in total — are deductible to you.
4. Payments to Independent Contractors (1099)
Many real estate agents and insurance agents are independent contractors. Independent contractors are also popular in the construction industry. If a business pays somebody for their services, that person is an independent contractor.
5. Wages Paid to Employees (W-2)
These are hourly wages and salaries paid to employees.
If a business owns a building, it can deduct the property insurance and personal liability insurance premiums.
If your business has taken a loan for capital expenses such as purchasing a building, buying a van for deliveries, or buying equipment, you can deduct the interest paid on the loan.
8. Legal and Professional Fees
Most businesses have an attorney and an accountant to help make informed business decisions. The amount you pay them for their professional services is deductible.
9. Office Expenses
Think about all of the paper, pens, paper clips, staples, and notebooks your business uses. Office expenses may also include software. These costs along with postage are deductible expenses.
10. Rent or Lease
Do you rent or lease a building and equipment? If so, these costs are deductible.
11. Repairs, Maintenance, and Cleaning
Repairing, maintaining, and cleaning of buildings and equipment is deductible.
These are small items used and consumed by a business. Supplies may include small tools, small pieces of equipment, janitorial products, coffee, cell phones, etc. Office expenses and supplies have some overlap and can get confusing. I’ve yet to see a clear-cut definition of each category.
This is a gray area in which judgment should be used.
Some office expenses and supplies may be categorized interchangeably. Categorize expenses to the best of your ability. Act reasonably and in good faith. Be complete and accurate. I believe getting the numbers correct is the most important aspect here.
Real estate taxes, property taxes, and other business taxes are deductible. Real estate taxes are imposed on land and real estate. Property taxes are on things like cars and boats. Real estate and property taxes vary from state to state. Income taxes paid by the individual on business profits are not a deductible expense.
Business licenses and regulatory fees paid to the government and other professional organizations are deductible.
Out-of-town travel for business purposes — including lodging and transportation — is deductible.
Business meals while traveling away from home are 50 percent deductible. Business meals also qualify for a 50 percent deduction. When in doubt, I highly recommend reading, researching, and consulting with a tax professional. It is a confusing topic even to professionals. To read more about what the government says, click here.
Whether you own or lease property, your business utilities are deductible.
18. Health Insurance
If you own and operate a business, your health insurance is deductible. If your business pays health insurance premiums for employees, these costs are also a deductible expense.
Depreciation is the process of expensing business property over time. The total cost of a building is not deductible in year one. Only a fraction of the amount is deducted—you can find more information here (take a look at page 29).
For example, residential property like a rental house is depreciated over a 27.5-year period and nonresidential property like an office is depreciated over a 39-year period. The IRS determines the recovery periods. They estimate the useful life of an asset.
20. Car and Truck
When a vehicle is used for business purposes, the IRS permits the business to deduct the cost of operating the vehicle in one of two ways:
- Standard mileage rate: The standard mileage rate is 57.5 cents per mile in 2020. For every business mile driven, the business gets a deduction. For example, if a business owner drives 10,000 business miles, they’ll get a $5,750 deduction (10,000 x .575). This is the simpler method for business owners.
- Actual expenses: This method is more complicated. This method requires the business owner to keep track of all business miles driven as well as receipts for all gas, oil, tires, repairs, insurance, maintenance, registration fees, and licenses. It also includes depreciation or lease payments.
See more information here.
21. Parking and Tolls
You can deduct parking fees and tolls if your business requires you to travel.
22. Home Office
The office must be used “regularly” and “exclusively” for business.
There is a restriction on deducting the approximate square footage of your home used for business and using that percentage in your calculations for how much rent or mortgage you can deduct.
Here’s how it works: Let’s say my apartment is 1,000 square feet, my office is 100 square feet, and I pay $1,000 a month for rent. My office is 10 percent of my apartment (100/1,000). I can deduct 10 percent of my rent, insurance, repairs, maintenance, and utilities.
If I owned a home, I could deduct 10 percent of my mortgage interest and real estate taxes. For more information, see the IRS website.
The Bottom Line
Some of the expenses listed may not apply to your businesses, or your business may have expenses not listed. This list is not all inclusive. If you need something for your small business and use it for that purpose alone, chances are you will be able to have a tax deduction. Be creative. Use your imagination.
Expenses vary business by business and industry by industry. Each industry has widely accepted business expenses. Most businesses in the same industry will have similar expenses. A bank will have different expenses than a trucking company. A hotel will have different expenses than a grocery store. A home builder will have different expenses than a law office.
The IRS website is a great resource. It offers a ton of free information about small business tax deductions. All IRS forms with corresponding instructions are available online here. I frequently refer to IRS publications, as they provide detailed information about various tax topics.
Just like in a football game, there are many variables in taxation.
There’s a fine line between winning and losing. There’s little room for error.
Remember, you must play both offense and defense. Some calls will go your way while others won’t. Learn to play in all elements. There are times to be aggressive, and there are times to play it safe. Every play matters. Just how every point adds up in a football game, every dollar adds up in taxation. Take every dollar you can get. You will win some, and you will lose some.
In the game of taxation, tax professionals are your biggest fans, as the IRS referees.