Small businesses often find themselves in a fix when they want to grow but are constrained by tight financial circumstances. Even with a brilliant product or service and tons of customers clamoring to use it, having the right tools to minimize financial woes always helps!
Thankfully, several tax credits, incentives, and grants encourage small business growth. Similarly, tax deductions also help save money by reducing the amount of taxable income that the business has, which in turn lowers the amount of tax owed.
In this blog post, we will explore the different small business deductions and credits geared specifically for operations of your size and how you can claim them as long as you meet the necessary qualifications. Let us begin:
Small Business Tax Deductions
Although net sales are the first thing you see on your business income statement, a small business tax deduction is an expense deducted from that income to lower the taxes you have to pay. Basically, tax deductions decrease your taxable income, resulting in a smaller tax bill.
Doing this can save a significant amount of money on your taxes, possibly even hundreds or thousands of dollars. Here is a list of the most common small business tax deductions you should take advantage of for your small business:
All business-related utilities, such as water, electricity, trash, and telephone bills, are fully deductible expenses for your business. You can also deduct these expenses if you rely on phone and internet services to run your small business. However, only the percentage of the cost for your business use can be written off.
For instance, if 40% of your internet usage is used for business and the remaining 60% for personal tasks, you can only deduct 40% of the total internet expenses incurred in that year.
Make filing your tax return a breeze by keeping detailed records and receipts of all your invoices and expenses related to your business, including the date, amount, and purpose of each expense. Then, deduct these expenses from your Schedule C for creating monthly reports of business income and expenses.
2. Bad Debts
According to the IRS, bad debt is defined as a loss resulting from the worthlessness of a debt that was either created or acquired in a trade or business or closely related to your trade or business when it became partly or totally worthless.
If you have lent money to an employee or vendor and they have failed to pay you back, you can claim the loss as a ‘bad debt’ deduction on your tax return. However, you must demonstrate that the debt was a business debt, not a personal one.
Business bad debts that may qualify for a deduction if previously included in income include loans to clients, distributors, suppliers, and employees, business loan guarantees, and credit sales to customers.
When you purchase furniture, equipment, and other business assets, the IRS requires you to spread the costs of those assets over the years you will use them instead of deducting the total cost in a single year.
However, expending these items upfront can be more attractive due to the massive tax benefit. You can write off the total cost of assets that cost less than $2,500 per item in the year purchased through the ‘de minimis safe harbor election.’
In addition, deduct up to $1,080,000 of property placed in service during the tax year, including new and used business property and off-the-shelf software. However, this is limited to your business's taxable income, and any unused deduction can be carried forward and claimed on the next financial year’s tax return.
On the other hand, amortization for intangibles like trademarks, patents, and copyrights is valued using a process that deducts the same amount each year. The amortization calculation is based on the original cost divided by the number of years, with no value at the end.
To claim a deduction in either depreciation or amortization, determine the type of asset and choose a method for it, keep accurate receipt records, complete the IRS Form 4562, and calculate and report the deduction on your tax return.
5. Office Supplies
Similarly, office supplies such as paper, printers, notepads, pens, laptops, and other work-related equipment are also deductible as long as they are used for business purposes within the same year of purchase.
6. Auto Expenses
If you use a car for business purposes, you can deduct all car expenses related to it. However, you must keep records that demonstrate business usage and track your mileage. You can do that by using a mileage reimbursement calculator.
Alternatively, you can use the IRS standard mileage rate, which is:
- 58.5 cents per mile for the first half of 2022
- 62.5 cents per mile from July 1st to December 31st, 2022.
In 2023, this rate has increased to 65.5 cents per mile.
Therefore, if you use your car for both business and personal reasons, you must apportion your expenses based on actual mileage.
7. Business Meals
You can deduct 50% of the cost of food and drink purchases related to your small business. To qualify for the deduction, you must keep documentation that includes the date and location of the meal, the business relationship of the person or people you dined with, and the total cost of the meal. The simplest way to track business meal expenses is to keep your receipt and make notes on the back about the specifics of the meal.
8. Employee Wages
As a small business owner with employees, the following come under business tax write-offs: salaries, benefits, and even vacation pay. However, there are specific requirements that you need to meet, such as ensuring that:
- The employee is not a sole proprietor, partner, or LLC member of the business
- The services delegated to the employee were provided
- The salary is reasonable and necessary
To report employee wages, use IRS Form W-2, which is used to report wages and taxes withheld for every employee. Provide the form to each employee by January 31st of the following year, and file copies with the SSA and the IRS.
9. Office Furniture
Office furniture is considered a type of office supply and can be deducted similarly to other office expenses like printer paper or cleaning products. Therefore, if you purchase furniture for your small business, it will fall under deductible business expenses on your tax return.
10. Travel Expenses
If you frequently travel for business purposes, deduct travel expenses from your tax return. To qualify as a travel expense, it must be incurred while you are away from the city or area where you typically conduct business, and you must be away from your tax home for more than an entire workday. Deductible travel expenses include tolls, taxis, airfare, and lodging expenses.
11. Contracted Labor
If you use independent contractors or freelancers as part of your labor force, the cost of hiring contracted labor is a tax-deductible business expense. However, you must issue a Form 1099-MISC to any contract worker who received $600 or more from you in a given tax year. In addition, if the worker is being paid via credit card or PayPal, the payment processor must issue Form 1099-K to the worker.
12. Moving Expenses
If you move and the primary reason for doing so is work-related, you can deduct the costs associated with the move. To qualify, your move must meet the distance test. To pass the distance test, your new job location must be at least 50 miles farther from your former home than your old job location was from your previous home.
13. Work-Related Car Use
If you use your car solely for work-related purposes, deduct all costs associated with operating and maintaining it on your tax return. However, if you use your vehicle for both business and personal reasons, separate the expenses related to the business usage.
To calculate your tax deduction, either deduct the actual expenses incurred for business use or use the standard mileage deduction, which was $0.56 per mile driven for the 2021 tax year.
14. Home Office Expenses
In 2020, during the COVID-19 pandemic, the IRS introduced simplified guidelines for home office expenses that enable home-based small businesses and freelancers to claim a deduction of $5 per sq. ft. of their home used for business purposes, with a maximum of 300 sq. ft.
However, your work area must be used exclusively for business to qualify for this tax deduction. You cannot claim the square footage of any space that serves as a dual-purpose area, such as a living room used as a workspace during the day.
Additionally, you must regularly use your home office as your primary place for conducting business to be eligible for this tax deduction. To determine the allowable expenses for the business use of your home, use IRS Form 8829 and report the amounts on Schedule C (for sole proprietors), Form 1065 (for partnerships), or Schedule E (for rental income).
15. Business Property Rent
If you rent a business location or equipment for your operations, you can claim the rental payments as a business expense deduction. However, the rent paid on your home cannot be considered a business expense, even if you have a home office. So instead, deduct it from your home office expenses.
16. Software Subscription
If you have purchased or downloaded software for your business, remember that these are deductible business expenses from your tax return. This type of expense can be claimed under the “Other Common Business Expenses>Other Miscellaneous Expenses” category on your Schedule C tax form.
17. Business Entertainment
If you entertain clients by providing them with meals and events, you may be able to deduct these expenses as long as they are necessary for your small business. However, it is essential to note that in most cases, meal costs are only deductible up to 50% of the total expense (although for 2022, this was raised to 100%).
However, some types of meals, such as those provided at office parties, are 100% deductible. To maximize this deduction, saving your receipts and documenting the business purpose of the meal or event is essential.
18. Child and Dependent Care
You can claim a tax deduction on your expenses for caring for your children or adult dependents. If you have children who are 12 years old or younger, deduct the expenses associated with their care.
Adult dependents, including spouses and certain other related adults who are unable to care for themselves due to physical or mental disability, also qualify for deductions.
19. Advertising and Marketing
As long as you have evidence that advertising and marketing expenses are related to your small business, you can claim a tax deduction for the money spent. This includes money spent on billboards, business cards, direct mails, or hiring a freelancer to design a business logo.
20. Employee Benefits Programs
Healthcare plans are essential benefits employees expect from their employers, and such financial wellness programs are often the most expensive. The good news is that your contributions towards your employees’ health insurance coverage can be considered a tax credit.
The criteria are:
- Having a staff of fewer than 25 full-time employees.
- Paying premiums that are under the SHOP Marketplace.
- Giving an average annual salary less than the amount prescribed by the IRS.
Health Reimbursement Arrangements, or HRAs, offer a flexible and accessible option for small
businesses. Instead of funding a group health plan, set a monthly budget for benefits and reimburse your employees tax-free for plans they choose on the individual market.
In addition, leverage Section 125, which refers to the pre-tax deductions your employees can make towards their employer-sponsored health care plans, flexible spending accounts (FSAs), and other benefits.
By offering certain tax deductions, your small business can lower its payroll tax while also reducing your employees’ taxable income, benefiting both parties. Additionally, if you provide paid leave for medical and personal reasons, you may be eligible for a tax credit ranging from 12.5% to 25% of the leave paid to the employee.
Lastly, contributions made to your employees’ retirement plans and your own are usually deductible within certain limits. You may also be eligible for the Retirement Plans Startup Costs Tax Credit, which enables you to claim a tax credit for costs associated with starting a SIMPLE IRA, SEP, or a qualified plan.
Tax Credits for Small Business
Tax credits are a way to reduce the tax bill of your small business by a certain dollar amount or percentage of a specific cost, making them an effective way to alleviate tax liability. Let us take a look at various tax credits that you can benefit from:
1. Research and Development (R&D) Tax Credits
The R&D tax credit is a government-sponsored tax benefit designed to incentivize US businesses of all sizes by compelling them to invest in innovation and increase technical jobs in the country.
This credit allows you to substantially reduce your tax liability at both federal and state levels by performing your day-to-day activities as long as you develop, design, or improve products, processes, formulas, or software.
To claim the R&D tax credit, evaluate and document your research activities, including keeping records such as payroll, expense detail, project lists, project notes, and documents produced through the normal course of business.
These records and credible employee testimony can serve as the basis of your R&D tax credit claim. Complete and file IRS Form 6765 (Credit for Increasing Research Activities).
Your small business can claim the credit for current and prior tax years. It must ensure, however, that it is eligible to claim the credit for all open years by accurately documenting its R&D activities.
2. Small Business Health Care Tax Credit
The Affordable Care Act (ACA) includes provisions that specifically benefit small businesses, including special insurance options through the SHOP program for employers with less than 50 employees. The small business healthcare tax credit is another feature of the ACA, available to businesses with less than 25 employees and calculated on a sliding scale based on size.
Enroll your small business in a SHOP plan to qualify for this tax credit and ensure each employee has an average salary of $56,000 per year or less.
The maximum credit is 50% of premiums paid for small businesses and 35% for small tax-exempt employers and can be claimed for two consecutive tax years with any excess credit carried forward or back to other tax years.
Use the IRS Form 8941 instructions for this tax credit. In addition, the excess amount paid for employer health insurance premiums over the allowable credit can also be claimed as a business expense deduction.
3. Work Opportunity Tax Credit (WOTC)
This credit allows you to meet your business needs while also benefiting from a tax credit if you hire individuals who have historically faced US employment barriers. That includes veterans, ex-felons, and Supplemental Nutrition Assistance Program (SNAP) recipients.
To claim the WOTC, businesses must obtain certification verifying that the new hire is a targeted group member. Once certified, taxable businesses can claim the WOTC as a general business credit against income taxes, while tax-exempt companies can claim it against payroll taxes. The credit can help offset training costs and assist with integrating new employees into the workforce.
To claim WOTC on your tax return, complete IRS Form 5884 with detailed information about the qualified employee and the credit amount you claim. After completing the form, include the credit on your business tax return following the IRS instructions.
4. Energy Efficiency Tax Credit
The US offers several tax credits to encourage energy efficiency for homeowners, manufacturers, and business owners. Some examples include tax credits for commercial building energy efficiency, energy-efficient residential housing, solar investment, and renewable energy such as wind turbines and geothermal heat pumps.
These incentives positively impact the environment and financially benefit small business owners. For example, the Section 179D commercial building deduction offers up to $1.80 per square foot deduction for energy efficiency improvements.
The solar investment tax credit (ITC) allows you to offset income tax liability by 26% of the cost of solar equipment. These credits can increase your business ROI and influence investment decisions to invest in the US instead of overseas.
Over To You
Now that you know the financial tools you have for your small business, remember to keep proper and accurate records of all your business expenses and consult with a tax professional to ensure all available small business tax deductions and credits are claimed on time. Become smarter in managing your business’s tax liabilities and keeping more money in your pockets.
All the best!