If you’re a small business owner, there’s a good chance thinking about taxes stresses you out.
If you’ve ever felt anxious about filing taxes, you’re not alone:
- The fear of making a mistake on taxes terrifies many people
- A study found that getting correspondence from the IRS made almost half of Americans feel anxious
- The same study found almost 1/3 of people are afraid of being audited
Well, there’s good news: tax preparation doesn’t have to be that intimidating. With this list of deductible business expenses at your disposal, you can easily lower your income tax bill — all without worrying about fines and penalties, preparing your small business taxes without help, or being an expert on the complicated U.S. Tax Code.
Download our free 2020 Small Business Tax Deductions Worksheet, and we’ll walk through how to use it right now in this very blog post. When we’re done you’ll know exactly how to reduce your income tax bill by making sure you’re claiming all the tax deductions available to your small business.
Ready? Let’s dive in.
Disclaimer: This blog post is intended to provide generalized information designed to educate a broad segment of the public. It’s not personalized tax, investment, legal, or other business and professional advice. If you have questions, talk to a qualified professional.
What is a tax deduction?
Nobody likes to pay taxes.
The good news is there’s a legal way to reduce the amount you owe to the government in taxes.
It’s called a tax deduction, or “tax write-off” and it lowers your taxable income, which in turn lowers your tax liability.
Tax deductions are expenses you can deduct from your taxable income. Essentially, you subtract the amount of the expense from your taxable income allowing you to pay a smaller tax bill.
How do business tax deductions work?
Tax deductions can save you money on your tax return but how exactly do they work?
When you take a tax deduction, what you’re essentially doing is exempting a certain part of your income from taxation. Your actual tax savings will depend on your effective tax rate. So, if you earn $50,000 a year and qualify for $5,000 in tax deductions you’ll only be liable for taxes on $45,000 of that income. Assuming your effective tax rate is 25%, that $5,000 tax deduction will save you $1,250.
So, what can a small business write off in their taxes?
Most people don’t take full advantage of the tax deductions available to them. A QuickBooks study found one in 10 businesses don’t take advantage of tax deductions. In fact, the IRS is holding $1.4 billion in unclaimed federal income tax refunds.
If you’re wondering what business expenses are deductible in 2020, the short answer is: it depends.
A business expense must be both ordinary and necessary to be considered deductible.
- The IRS considers an ordinary expense to be one that’s common and accepted in your trade or line of business.
- Necessary expenses are expenses considered helpful and appropriate for your trade or business. An expense doesn’t have to be indispensable to be considered necessary.
It’s important to separate your business expenses from your personal expenses so you can easily claim all of the small business tax write-offs your business is eligible for.
And, speaking of tax write-offs…
What expenses can you write off as a business?
If you’re a sole proprietor, or your business is organized as a partnership or limited liability company (LLCs), here’s a list of tax write-offs you may be able to claim.
- Business use of your car — If you can document and verify your vehicle is used for business purposes, you can deduct the operation costs. You can choose to use the simple deduction — which was 58 cents per mile in 2019 — or you can itemize specific costs. Check with your tax professional since this changes all the time.
- Home office — If you have a dedicated workspace in your home you use regularly and solely for business, then you’re eligible to deduct expenses related to that portion of your home. You can use the simple option — where you take $5 per square foot up to 300 feet — or you can break it down as a percentage of the total square footage of your home and itemize your costs related to the space.
- Bonus depreciation — This tax deduction is a result of the Tax Cuts and Job Act of 2017. Essentially, it’s a first-year “bonus” depreciation that applies to depreciable business assets. Now, instead of depreciating qualified property by 50% the first year you purchase it, you’re allowed to depreciate certain assets by 100% if you purchase them and use them after September 27, 2017, and before January 21, 2023. According to the IRS property like vehicles, computers, software, machinery, and equipment qualify for this “bonus” depreciation.
- License fees — You can list any license fees you pay as a valid deduction. The catch: You can’t write-off education that qualifies you for a new career. But, any license fees you pay are a valid deduction. You can also write-off the license renewal fee and any continuing education required to maintain your license (including tuition, books, fees and research). You can write off education for a certification test if earning the certification will improve your existing business. This deduction also applies to federal, state, and local licensing as well.
- Salaries and benefits — Any salaries, wages, commissions, or bonuses you pay your employees are typically tax-deductible expenses. This includes sick leave, vacation pay, education expenses, reimbursements, and loans to employees. The IRS rule is your expenses must be “ordinary and necessary,” “reasonable in amount,” “paid for services actually provided”, and “paid for or incurred in the current year.” You can also write-off Federal Unemployment Taxes (FUTA), State Unemployment Taxes (SUTA), payroll processing, and payroll taxes for employees, including Social Security, Medicare taxes and unemployment taxes.
- Work Opportunity Tax Credit — If you employ people from certain groups – ex-felons, veterans, SSI recipients, the underemployed, summer youth employees – you can apply for a Work Opportunity Tax Credit. You have to file Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit with your state workforce agency within 28 days of the eligible employee beginning work. If you’re approved, you can receive tax credits between 25% and 40% of the first $6,000 in wages paid to those employees.
- Office supplies and expenses — If you have receipts, the IRS allows small-business owners to deduct 100% of office supplies. Your office operating expenses are handled differently on your business tax return. The IRS allows small business owners to deduct or depreciate office expenses. For more information on how to deduct (or depreciate) office expenses on your small business tax return, go here or here.
- Client and employee entertainment — This is one of the small business deductions that was affected by the Tax Cuts and Jobs Act. Because of those changes when it comes to entertainment, you can now only deduct the cost of meals and beverages. Entertainment expenses like taking a customer to a sporting event, resort, or for a few rounds of golf are no longer allowed.
- Freelance/independent contractor labor — You can deduct wages paid to independent contractors from your taxable income. Typically you provide your contractor with IRS form 1099-MISC and send the IRS form 1096 which shows how much you paid the contractor.
- Furniture and equipment — For tax purposes, small business owners can deduct up to $1 million worth of purchases under Section 179. This includes office furniture, machines, equipment, SUVs, pickups and vans weighing more than 6,000 pounds.
- Permits and fees — Any fees associated with business bank accounts and loans are deductible including monthly service fees, ATM fees, overdraft fees, deposit fees, wire transfer fees, annual fees, late payment fees, set-up costs for loans, leasing fees for equipment and interest. Resale permits and permits required by government agencies can also be deducted.
- Computer software — You can deduct the cost of software you use to run your business. If you use apps that have a monthly subscription, you can deduct that expense as well.
- Rent on your business location — If you rent a business location, you can deduct the rental payments as a business expense. The cost of renting a space for your business is fully deductible, even if you use a monthly co-working space.
- Startup expenses — The IRS allows business owners to deduct $5,000 in business startup costs and $5,000 in organizational costs if total startup costs are $50,000 or less. If your startup costs in either area exceed $50,000, your allowable deduction will be reduced by that dollar amount.
- Utilities — You can deduct utility bills like heat, electricity, water, Internet on your taxes. Like any other deduction, you’ll want to have proof of the expenses if needed.
- Parking and tolls — The IRS allows you to write-off business-related tolls and parking fees. The same tax provision allows you to deduct shipping of baggage, and sample or display material between your regular and temporary work locations, dry cleaning and laundry, and any tips you pay for services related to any of these expenses.
- Taxes — Depending on your business structure, you may be able to write off regulatory fees, taxes on real estate and personal property, your employer taxes, including the employer share of FICA, FUTA, and state unemployment taxes.
- Commissions — Commissions paid to salespeople and third-party commissions are tax-deductible.
- Machinery and equipment rental — You can potentially deduct these expenses in the year you incur them. This is a great alternative to using depreciation (which would be the case if you purchased the machinery or equipment).
- Inventory for service-based businesses — You can take tax deductions for the cost of purchasing building materials or for inventory you later resell for a profit. You can only take this deduction for inventory you actually sell during the course of the year. Purchasing inventory isn’t a tax deduction until you sell the inventory items, or they’re deemed “worthless” and removed from your inventory.
- Bad debts — If someone owes you money that you can’t collect, you may be able to write it off. Examples of bad business debts include loans to clients, suppliers, distributors, and employees, credit sales to customers, or business loan guarantees
- Employee education and child care assistance — The Internal Revenue Service allows small business owners to claim between 10% to 25% of the cost of employees’ child care expenses—or up to $150,000—each year.
- Mortgage interest — Small business owners can deduct mortgage interest, taxes, maintenance and repairs, insurance, utilities and other expenses on properties used for business purposes.
- Tools — As a business owner, you can claim a deduction for inexpensive tools or tools that have a lifespan of one year or less.
- Disaster and theft losses — You may be able to claim a deduction for expenses related to natural disasters or theft.
- Carryovers from previous years — If you have a tax loss in one year, you may be allowed to use that loss to offset profits in future years. This can help minimize your taxes. You might be able to claim a tax loss against state income taxes as well.
- Lawn care expenses — If your property is rental property or if you have a home office you may be able to write-off these expenses. The rule is that the state of your lawn has to have some relevance to the performance of your business, for example as a play area for your daycare business.
- Home renovations — If you’re already claiming a deduction for a home office, business expenses related to any renovations to that part of your home are also deductible. Plus, you can deduct the percentage of your homeowner’s insurance that covers that part of your home.
- Tax preparation fees — If you hire a tax professional, like a Certified Public Accountant (CPA) to prepare your business tax return, the fees are tax deductible.
- Unpaid goods — If you sell goods that haven’t been paid for yet, you can deduct the cost. Unfortunately, this doesn’t apply to service businesses.
How Neat can help with your small business accounting
The Internal Revenue Service has one goal: collecting revenue.
Nothing wrong with that. Except most small business owners are out to make and save money, not give it to the government in the form of taxes. Luckily, when you claim all the tax deductions available to your small business, you can easily lower your income tax bill.
But, to claim these deductions, you’ll need to keep accurate records and keep up with your bookkeeping.
And that’s where Neat can help.
Say “goodbye” to cramming all your paper receipts in a file or box so they can be sorted through later. We can help you keep track of your receipts and recurring expenses.
And when you track, manage and centralize your financial data using Neat, you’ll be prepared for tax time.
Here at Neat, we’re always looking for new ways to simplify accounting for our small business customers… people like you! So, don’t forget to download your 2020 Small Business Tax Deductions Worksheet. It lists 60 small business tax deductions for small businesses looking to maximize their deductions.
NOTE: Some of the deductions in this list may not be available to your small business. Consult with your tax advisor or CPA before claiming a deduction on your tax return.
Want to see how to maximize deductions and audit-proof your business? Try Neat free for 15 days! Cancel anytime.