One of the keys to maximizing the profit potential of your small business—even one that isn’t ready to make a lot of money yet—is to reduce your income taxes. Depending on how your company is structured, you have an opportunity to take advantage of a wide variety of business tax deductions.
What is a Business Tax Write Off or Deduction?
When you write off a business expense, it doesn’t mean you deduct that amount from your tax liability. It means that you don’t pay taxes on this amount (if you owe taxes).
For example, if your small business generates $25,000 in sales and you have $10,000 in expenses, you have a pre-tax profit of $15,000. The amount of income tax you’ll pay will be based on that $15,000. Depending on where you live, your federal and state income tax on that $15,000 pre-tax profit might be $5,000, leaving you a net profit of $10,000 to put in your pocket.
Keep in mind: If, for example, at the end of the year, you decide to buy a $1,000 software program for your business, this doesn’t mean that you subtract the $1,000 software cost from your $5,000 tax bill. You subtract the $1,000 from your $15,000 profit, meaning your profit was only $14,000. You now pay your income tax on a profit of $14,000 instead of $15,000.
Keeping track of and claiming all of your legitimate business deductions is worthwhile for small-business owners. However, starting a business that won’t earn much money because you think you can write off vacations, auto costs, home office expenses and other costs just isn’t a good idea. You won’t have enough legitimate expenses to make running a business worth your while, and you might unintentionally stray into illegal deductions (especially if the IRS decides your business is actually a hobby). All deductions must be for necessary and ordinary business activities.
Record Keeping is Key
If you keep track of all of your qualifying business deductions, you can significantly reduce your tax bill each year and keep more money in your pocket. Many small-business owners fear “red flags” that cause IRS audits. The more flags you have, such as a home office, the more you increase your chance of an audit, according to Kevin Hood, owner of C. Kevin Hood Accounting & Tax, Hilton Head Island, South Carolina. “A home office isn’t an automatic audit, but IRS computers do ‘score’ returns based on industry or profession norms for specific items, issues and amounts,” says Hood.
Thousands of Americans claim a home-office tax deduction each year without being audited. If you keep good business records and have a tax expert look at your deductions each year, you should have no problem with your taxes even if the IRS audits you.
A home office must be used exclusively for business. You can’t put a desk in your kitchen, workout room or nursery and claim that square footage as a home office. The space must also be your primary place of business or a place where you meet clients. If you store materials in your garage (where you park your car and keep other items), you can’t write that space off. The good news is, if you qualify for a home office deduction, you can include the total expense of that square footage as a business deduction. This expense includes your rent or mortgage, property taxes, insurance and utilities.
You can deduct auto and travel expenses one of two ways. You can use the mileage deduction provided by the IRS, or deduct specific expenses. If you take the IRS deduction, you can claim 57.5 cents for every mile driven (as of 2015). This covers your gas, oil and vehicle wear and tear. If you drive 100 miles on business, your mileage expense is $57.50. If you stop and fill up your gas tank, you can’t deduct that expense if you take the mileage deduction.
You can use your car for work and personal errands, but you can only deduct your business mileage. Auto deductions are only available for business owners or contractors—commuting to and from your regular place of work isn’t deductible.
The IRS limits what you can deduct when it comes to business meals. For example, if you’re in town, you can’t deduct a meal. If you take a client to dinner, you can deduct 50 percent of the meal. If you are traveling alone on business, you can deduct 50 percent of your meal. You’ll also need to keep receipts to prove you paid for the meal.
You can write off travel expenses related to your business activities. This can be an excellent way to improve your job skills by traveling for a seminar, such as training on a specific type of software, taking a business-writing course or learning social media marketing. The main purpose of your trip must be business-related. It’s OK to visit friends or take in sights while you’re on a business trip, but you can’t write off a six-day vacation because you took a one-day business seminar. You would only be able to claim one night of your hotel room and the meals for that day as business expenses. You would most likely also need to pro-rate your airfare or mileage.
If you want to tack a vacation onto a legitimate business trip, you might be able stay a few extra days and deduct the airfare or mileage, which you would have had anyway if you had not vacationed those few days. Your primary purpose for flying or driving in this instance was business-related. You just can’t claim those extra room nights or meals during those days as deductions. There is an exception for this if you must stay over during a weekend, even if you have no business activities during that time. Check with your accountant before you book any trip to find out what your options are. Again, your primary reason for a trip must be business related if you plan to take any deductions. If you want to make sure you can deduct your airfare or mileage, talk with a tax specialist before you try to combine any vacation with business activities.
And again, keep in mind that starting a small business because you think you can write off vacations will get you in hot water.
Whether you use a personal credit card or open a small-business card, you can deduct the interest generated by business-related purchases. If the card is for business only, you can deduct any annual fee, late charges or penalties on missed payments.
As you can see below, your business expenses can add up to a nice tax-payment reduction if you claim them all:
- Business cards
- Post Office box
- Magazine subscriptions
- Professional membership dues
- Continuing education
- Computer equipment and software
- Website domain registration and hosting
- Marketing materials
- Professional services (e.g., tax preparation, website help, graphic design)
- Internet (only the portion used for business)
- Materials to make your product
- Postage and shipping
- Office furniture
- Bad debt (e.g., a customer stiffs you)
- Charitable donations
- Taxi, shuttle, parking
Taking all of your legitimate business tax deductions can take you from a struggling or marginally profitable company to one that makes it worth your while to continue. Keep good records of every dollar you spend on your business activities, and when it comes tax time, you might find a pile of money you hadn’t expected.
Sam Ashe-Edmunds has been a small-business consultant and owner for more than 25 years. He has written for a wide variety of magazines, newspapers and websites, including Entrepreneur, The Chicago Tribune, Chron Small Business, AZ Central Your Business, TheNest, Zacks, Motley Fool, Synonym Money, GlobalPost and Opposing Views.