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Surprising Things You Can Claim on Small Business Taxes…

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Starting a business can be a daunting venture. With steep upfront costs, heavily-crowded industries, and uneven playing fields, small businesses must find creative ways to grow while saving every penny in the process. Expenses incurred in the first year are often deductible, leaving you with some extra cash you may not have known you were entitled to. Following the first year, small business owners shift their focus towards lowering their tax bill with conventional write-offs, often overlooking the more niche deductions and credits. We’ve created a guide to help you better understand these deductions and all the surprising ways to save so your business can thrive in the startup phase and beyond.

For all the essential info, read on. If you’re just looking for the list of things you can claim, scroll down to the “Surprising Deductions” section.

Deducting Startup and Organizational Costs

  • Startup Costs: the costs of creating and preparing your business for launch. These costs include: visiting potential office spaces, market and product research, travel and advertising expenses, and employee training. It’s important to note that equipment is excluded from these costs since it’s depreciated over time. Make sure you include these expenses in your business plan, and keep records of all incurred costs.
  • Organizational Costs: All partnerships, LLC’s, and corporations are entitled to deduct what are referred to as organizational costs. These costs include legal and professional fees, accounting fees, and organizational meetings.

The IRS allows you to deduct $5,000 in both startup and organizational costs as long as the costs are below $50,000. If you exceed this amount, the IRS will only deduct the difference between $5,000 and the amount above $50,000. (So if you spend $52,000, you can only deduct $3,000 instead of the full $5,000.) If you end up exceeding $55,000, make sure to amortize the costs or your deductions will be lost entirely. Keep in mind, even if your costs stay below $50,000, you can still opt to amortize over 15 years — taking the same deduction each year. This option is especially viable if you don’t expect to have a lucrative business in the first year and want to lower your taxes when you do become profitable.

Common Tax Deductions for Small Businesses

Home Office Expenses Employee Salaries and Benefits
Rent Expense Taxes and Licenses
Advertising and Marketing Business Insurance
Office Supplies and Expenses Legal and Professional Fees
Utilities Debt Interest
Vehicle Expenses (Business Use) Depreciation
Travel Expenses Education
Business Meals (Clients/Employees)

Surprising Deductions for Small Businesses

What You Need to Know

C-Corp vs Pass-Through Entities

Choosing the type of entity for your business is one of the most important decisions you’ll make in the early stages of your business as it will determine the rate of your income tax. Historically, most small businesses would set up as pass-through entities: Sole Proprietorship, Partnerships, or S-Corporations. This was largely due to C-corps being subject to double taxation on top of the 35% income tax rate. However, with The Tax Cuts and Jobs Act of 2017 now only requiring C-Corps to pay up to 21%, choosing between a C-Corp and a pass-through entity has become increasingly more difficult. Although C-Corps are still subject to double taxation, the tax rate is much more competitive. There are advantages to both so it will likely come down to the amount of profits or losses you expect your business to generate.

Income Tax

The United States uses a marginal tax rate system that is best explained by: the greater the income, the higher the percentage of the tax. Since tax rates play such a pivotal role in deductions, it’s important to know how your business will be taxed. Owners of S-Corps, LLC’s, and General Partnerships will report their income as individuals would on their personal tax return and will pay taxes according to their income bracket. Owners of C-corporations are only required to pay up to a 21% rate, regardless of income.

Ordinary and Necessary

Because the IRS doesn’t specify deductions across every industry, your write-offs will come down to an oddly vague rule – “Ordinary and Necessary.” Put simply, if your business requires certain assets or services to operate, you can write those expenses off. If you’re a dental hygienist, cleaning tools would be considered necessary items to your business. But if you try to expense that new 50” TV in the lobby that you deem fundamental to the aesthetic of your business, you may have a hard time proving it. Although grey areas like these certainly exist, most deductions will be clear and obvious. As with any business, it’s best practice to keep records of all your expenses to avoid any complications with IRS, and to provide explanations for questionable write-offs.

Tax Credits vs Tax Deductions

Both tax credits and tax deductions work to lower your tax bill, but they have discernible differences that often make credits superior to deductions. While tax deductions lower your taxable income, tax credits directly decrease the amount of tax you owe. In other words, tax credits reduce your tax bill dollar-for-dollar, disregarding the tax bracket.

Example: Jenny has an AGI of $40,000 and falls into the 20% tax bracket, leaving her with a tax bill of $8,000. Fortunately, she has the option to take a $2,000 tax deduction or a $2,000 tax credit. Since she can’t claim both for the same expense, she’ll have to calculate the savings between the two to see which one saves her the most money.

  • Tax Deduction: ($40,000 – $2,000) = $38,000 → ($38,000 x 20%) = $7,600

    • Jenny’s tax bill would be $7,600 after the tax deduction.
  • Tax Credit: ($40,000 x 20%) = $8,000 → ($8,000 – $2,000) = $6,000
    • Jenny’s tax bill would be $6,000 after the tax credit.

Jenny would take the tax credit, rather than the deduction which would have only saved her $400. It’s not hard to see why business owners love tax credits as they can often save hundreds, sometimes even thousands of dollars. Unfortunately, most good things come with limitations, and tax credits are no different. Most tax credits are nonrefundable, meaning if your tax bill is lower than credit, you won’t get a refund for the remaining amount. This can be troublesome if you don’t owe a lot in taxes to begin with, but for most business owners, this shouldn’t be a concern.

Surprising Deductions 

  1. Child Care Expenses: If you pay for child care while you are at work, you may be able to claim the Child Care Tax Credit.

    • Requirements

      • Child must be under the age of 13
      • Expenses only relating to child care while you’re at work. For example, you cannot deduct the costs for a babysitter if you go out for a night.
    • Deductions and Credits
      • Tax credit of up to 35% if your income exceeds $15,000/year.
      • Tax credit of up to 20% if your income exceeds $43,000/year.
      • Allowable expenses of $3,000 for one child and up to $6,000 for two children.
  2. Moving Expenses: If you moved your business to a new location, you may be able to claim the moving costs. Make sure you keep records of the specific expenses.
    • Requirements

      • Expenses must be ordinary and necessary to the move
      • Must travel at least 50 miles from your previous location
      • Must work 39 full weeks within the first year after the move
    • Deductions and Credits
  3. Bank Fees and Charges: If you have separate business accounts and credit cards, you can deduct charges relating to transfer fees, overdraft fees, transaction fees, and annual service fees.
    • Requirements

      • Although there’s not a set limit, the IRS states that the fees can’t be excessive. For example, it’s going to be difficult to deduct overdraft fees if you business incurs them every week.
    • Deductions and Credits
  4. Machinery and Equipment Rental: If you rent equipment that’s vital to the operation of your business, you can claim a deduction for the entire cost.
    • Requirements

      • Rental expenses must relate to your type of business and must be necessary to operate it. For example, you rent an espresso machine for your coffee shop while your old espresso maker is being fixed.
    • Deductions and Credits
  5. Retirement Contributions: Similar to deducting contributions for employee benefits, business owners can also claim deductions to their own retirement contributions.
    • Requirements

      • Your contributions must stay within the limits of your retirement plan. For example, a traditional IRA plan states that you can only contribute up to $6,000 in 2019. Your deductions will vary with the amount contributed.
    • Deductions and Credits
      • Deductions will depend on the type of retirement plan you have. The IRS breaks down the deduction amounts here.
  6. Health Care Expenses: If you’re self-employed, you can deduct health insurance premiums relating to medical, dental, and long-term care.
    • Requirements

      • You can only claim premiums for months that both you and your spouse weren’t able to participate in any employer health plan.
      • The deduction must be less than your earned income.
      • Your revenue must exceed your expenses. In other words, you cannot claim the deduction if your business incurred a tax loss for the year.
    • Deductions and Credits
      • Other than long-term care coverage, you can deduct 100% of your premiums.
      • Deductions in 2019 for long term care depends on your age.
  7. Commissions: Similar to salaries and wages, if your business has salespeople that work on commission, you can fully deduct those pay-outs.
    • Requirements

      • Must fill out Form 1099-MISC if you paid out $600 or more
    • Deductions and Credits
  8. Computer Software: If you purchased software that is used for business purposes, you can deduct the full cost.
    • Requirements

      • Must be necessary to the operation of your business.
      • Must be used for income-producing activity.
      • Must have a useful life that lasts over one year.
      • Can’t be custom or “substantially modified.”
    • Deductions and Credits
  9. Work Opportunity Tax Credit: If you hired any qualified veterans, ex-felons, or individuals that have been unemployed for over 27 consecutive weeks, you may be eligible for this credit. Other groups that the WOTC targets can be found here.
    • Requirements

      • Must complete IRS and Dept of Labor forms during the hiring process
      • Must submit both forms within the first 28 days for individuals that fall into the WOTC targeted groups.
      • Employee must work over 120 hours in the first year
    • Deductions and Credits
      • 25% credit if the employee works over 120 hours.
      • 40% credit if the employee works over 400 hours.
  10. Freelance/Contractor Labor: If you hired a freelancer/independent contractor, you may be able to fully deduct those pay-outs. This includes costs from hiring a painter to work on your office to freelancers writing for your website.
    • Requirements

      • Must fill out Form 1099-MISC if you paid out $600 or more
    • Deductions and Credits
  11. Inventory: If you’re a service-based small business, you may be able to treat some inventory as non-incidental material or supplies. This can get a little tricky but if you adhere to the accounting rules, “supplies” you sell can become deductible.
    • Requirements

      • Must use the cash method of accounting
      • Must keep track of costs to acquire/produce the supplies
      • Can only deduct the cost in the year you sell them, rather than deducting in the year you produced/acquired them.
    • Deductions and Credits
  12. Disaster and Theft Losses: Hopefully you can avoid this deduction altogether, but in the unfortunate event that your business does fall victim to theft or a natural disaster, you may be able to deduct costs incurred from losses not covered by insurance.
    • Requirements

      • Must be a casualty loss — unexpected, sudden, or unusual. You won’t be able to deduct losses from things like termite damage or natural building deterioration. You can find a full list of non-deductible losses here.
      • Must file a claim for reimbursement with your insurance first
      • Your total losses on personal property must be over 10% of your adjusted gross income (AGI).
      • Must subtract $100 from each casualty or theft loss. Example: Stolen laptop worth $800 ($800 – $100) = $700. Your loss before the AGI reduction would be $700.
    • Deductions and Credits
      • Deductions will vary based on value and damage. Example: Steve has an AGI of $50,000 and wants to see how much he can deduct after his office, reduced by a value of $15,000, is damaged by a hurricane.

        • Total Loss: ($15,000 – $100) = $14,900; AGI: ($50,000 x 10%) = $5,000.
        • Deduction: ($14,900 – $5,000) = $9,900 
  13. Tools: Small business owners will be happy to know that the IRS differentiates between equipment and tools. Tools — such as cooking pans or pliers — that have an estimated life of one year or less are deductible expenses.
    • Requirements

      • Must be necessary to the operation of your business.
      • Must have an estimated life of one year of less, anything over a year is considered a long-term asset and must be depreciated.
    • Deductions and Credits
  14. Unpaid Goods: If you’re a product-based business, you can deduct the cost of goods that have yet to be paid for.
    • Requirements

      • Must be a product-based business. In other words, this doesn’t apply if your business provides a service. (Refer to Inventory)
    • Deductions and Credits
  15. Charitable Deductions: If you’re a business owner looking to donate to charity, you may be able to deduct your contributions.
    • Requirements

      • Must be a qualified organization. Most are, but it’s worth checking here.
      • Must itemize your deductions rather than expensing them
      • Contributions must be paid in cash or other property
      • Contributions must be paid before the end of your tax year
    • Deductions and Credits
      • If you opt to donate property rather than cash, you can deduct the fair market value of the property.
      • Most contributions can be deducted up to 50% of your AGI. Some private foundations or exclusive member organizations may be limited to 30%.
  16. Cleaning and Janitorial Expenses: Many business owners are surprised to hear they can deduct the cost for cleaning services.
    • Requirements: If you have a home office, you can only deduct the cost for rooms relating to your business.
    • Deductions and Credits: Fully deductible

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