Small business tax deductions: What are the best deductions and why?
Tax season has been quite different in 2021 compared to years past. Due to the circumstances of 2020, the IRS has extended the tax filing and payment deadline to May 17 for individuals -- including sole proprietors and single-owner LLCs, of small business. However, the questions that come during tax time remain, and one of the most common is, "How can I maximize my return?"
For those with small businesses, reducing taxable income and saving on the amount of money that must be paid to the IRS is of equal concern. Shaving more dollars off your tax bill is possible if you know where to look. Tax deductions are one way to accomplish this goal.
Tax deductions
Tax deductions give a business or an individual the ability to lower their tax liability when Tax Day rolls around. This tax liability is lowered by reducing taxable income -- the gross income the government deems subject to taxes. Tax deductions are one way this taxable income is lowered. Tax deductions are subtracted from taxable income, resulting in fewer taxes owed.
Standard deductions and itemized deductions
There are two types of tax deductions: Standard deductionsand itemized deductions. Tax filers have a choice between these two options. You cannot choose both.
Standard deduction
This is the easiest option for individuals claiming deductions. The standard deduction is an automatically set amount based on an individual's filing status: Married filing jointly, married, or single. Each state has its own standard deductions, but the IRS automatically sets the federal standard deductions for 2020 taxes to be filed in 2021:
- $12,400 for single taxpayers
- $12,400 for married taxpayers filing separately
- $18,650 for heads of households
- $24,800 for married taxpayers filing jointly
- $24,800 for qualifying widows or widowers
Itemized deduction
Itemized deductions are usually of greater concern to small business owners. No receipts are required with the standard deduction since it is a set amount based on filing status. However, those with a host of yearly expenses, like small business owners, may find better opportunities to save money with itemized deductions -- if you can back up the expense claims you are making.
It is important to note that small business owners can still claim the standard deduction on personal 1040 returns while also writing off business expenses on a Schedule C form. There are many great tax deductions for 2021, but let's look at some pertaining to small businesses.
Small business tax deductions
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Home office
Due to the pandemic and quarantines in 2020, the way we worked drastically changed. Thousands of employees moved to remote work; others used the opportunity to start their own small, home-based businesses. Home offices became a necessity.
Home office deductions can provide a bit of tax relief for small business owners. Most don't know that their mortgages or rent, the cost of utilities, cost of home repairs, and property taxes can all have an impact on tax savings. According to IRS Publication 587, a percentage of your home's square footage, the part used for business-related activities, can be tax-deductible.
According to new simplified IRS guidelines for home office expenses, small business owners who work at home offices can deduct $5 per square foot of the portion of their home used for conducting business. The maximum square footage allowed for a deduction is 300 square feet.
Even some home office supplies and expenses, such as shipping costs, postage, computers, and work-related software, can be deducted as long as they were used for business purposes within the given year. But make sure you keep all documentation and receipts for purchases.
Rent expense
Don't work out of a home office? That's OK, too. Per IRS Publication 535, if you rent a business location, you can deduct rental payments as a business expense. Rent is any amount of money you pay for the use of a property you do not own. This expense can only be deducted if used for your business or trade and if you are not receiving equity in the property.
Advertising expenses
Do you have advertising expenses related to your small business? If so, most of these expenses can be deducted as well. Per the IRS, you can deduct goodwill advertising expenses that are directly related to your business activities. However, no advertising used to influence legislation (lobbying) can be deducted.
Travel expenses
Some travel expenses can also be deducted from your taxes as they relate to your business. However, the trip must qualify as business travel. Per IRS Publication 463, travel expenses are the ordinary and necessary expenses of traveling away from your home for business purposes. Ordinary means that it is common or accepted in your business or trade, necessary means it is helpful or appropriate for your particular business.
Tax home refers to the city or area in which you conduct business. Traveling expense usually requires a place that is further away than a normal day's work -- somewhere that requires rest or sleep while en route to get there.
According to the IRS, approved business travel expenses that can be deducted may include:
- Transportation: Costs for travel between your home and the business destination via airplane, train, bus, or car.
- Travel fares: An example of fares include expenses like taxi costs (e.g., expenses you incurred from getting from the airport to your hotel).
- Vehicle expenses: This includes expenses that come from operating and maintaining your vehicle while traveling from home on business. You have the option to deduct the actual expenses or use the IRS's standard mileage rate. Tolls and parking can be included as well.
- Meals: Meals would include amounts spent on food and beverages if it is necessary to stop while traveling. Generally, there is a 50% limit on unreimbursed meals cost, actual expenses, or a standard meal allowance method may be used.
- Lodging: Lodging can be deducted as well, assuming it is necessary for your business-related trip; overnight is required, or it is long enough to require rest.
- Other expenses: Business communication expenses, such as business calls, faxes, and computer rental fees can also be deducted. Cleaning charges, such as dry cleaning and laundry, can even be deducted as a business expense.
It is essential to keep detailed records for these expenses, such as dates, details of the business trip (clients met), and a mileage log (if you used your own vehicle).
Finance
Charitable contributions
Similar to charitable donations used in individual, itemized deductions, charitable contributions can also be deducted for your small business. Cash payments to any charitable organization may be deducted as a business expense, assuming the donations are not directly related to your business.
Education expenses
Educational expenses related to training, maintaining, or improving skills pertinent to your existing business may be deducted. This does not include educational costs associated or moving into a different trade or new line of work or a hobby you may like.
A small business owner in real estate taking a course to better their skills in real estate market analysis qualifies, a small business owner taking a scuba diving course for fun does not. Get it? Of course, you must be able to prove that this particular education actually does maintain or improve your skills within your business or that it is, in fact, required (e.g., licensing).
This is also true for any educational expenses associated with employee training. Those expenses can be deducted as well.
Startup costs
Now, some good news for new small business owners: The IRS states that a small business can deduct up to $5,000 in startup costs in the first year of business. These startup costs include expenses like travel-related costs to meet new clients or investors, advertising and market research, and professional fees such as accounting or attorney fees. Of course, professional fees are deductible at any time for business owners.
Many credit card companies charge business owners a convenience fee when they sign up. This fee, when paid or incurred, can be deducted as a business expense.
Maximize your return
For many individuals and small business owners, tax preparation services and tax professionals stand ready to help explain and explore the ocean of tax deductions offered by the IRS in 2021.
The tax deductions listed are just scratching the surface when it comes to the number of potential tax deductions available for small businesses. But they are among the best. From startup costs to educational expenses, there is something available to benefit any small business this tax season.