Tax Deductions and Your Small Business
Posted on 03/30/2017 at 11:35 AM by Shannon Hoyle
Written by Dan Burden, AgMRC Program Specialist.
So, you have an agriculture-related small business? Are you sure that you are doing everything that you can do to maximize your profit margin, reflect your investment in your company and community infrastructure while still paying your fair share to the government?
This article is a simple guide to introduce you to the tax world as it pertains to small-business management. It is not a do-it-yourself how-to guide. There is wonderful software out there for the do-it-yourselfer. That said, most taxpayers and all business owners should regularly consult with a well-recommended certified accountant or tax professional to determine their deduction eligibility, as well as how depreciation and similar issues impact the year’s investment and performance goals. This is another area of sound business planning where no one person has all of the answers. Talk to people, do your research and the time that you invest in this subject will benefit you.
Let’s start by reviewing tax deductions. Tax deductions are intended to lower an individual or business’s taxable income, thereby beneficially changing the amount paid in federal and state taxes. The government encourages citizens and business ventures to invest in themselves and their communities. To reflect that, deductions are available for all sorts of things in all sorts of areas. Deductions fall into three distinct categories:
- Above-the-line deductions. Deductions subtracted from an individual's gross income and claimed by anyone who completes a Form 1040.
- Standard deductions. Determined by a taxpayer's filing status, subtracted from annual gross income. Examples include head of household, married filing jointly, single, eligible widow and married filing separately.
- Itemized deductions. Most applicable to small-business owners. Determined by specific purchases that can affect an individual's tax status (aka., wealth/profits). Examples include self-owned business, business loan interest, casualty, theft, charitable giving, property taxes, personal gambling losses, some business-related losses (aka, “business-gambling” losses), student loan interest that's paid by an individual's parents, and various other things.
With respect to individual taxpayers, if one has more itemized deductions than standard deductions one usually claims the later (this is simple common sense). Most individuals take the standard deductions, because they have rather simple tax bills and tend to do better with standard deductions than itemized deductions. With respect to small businesses, in-home offices, and start-ups; itemized deductions are the way to go.
If you are doing itemized deductions, want to understand them and not miss anything, the first critical step is to consider documenting everything that pertains to your situation. This can be as simple as getting a notebook, folder or large envelope and stuffing it with dated receipts, to developing a system on your computer that helps you to maintain those records. In today’s tech-savvy world there are some really neat phone apps that do this job quite well. The bottom line is that the more you can document your expenses, the smoother life will be at tax-preparation time. It really helps to have a cheat-sheet list of potential deductions that you can keep in your record book or with your expense information, that can help keep potential deductions from slipping away.
Let’s start with a quick list of things to consider. Firstly, there are two broad categories of expenses; everything falls into one category or the other.
Direct expenses: Money spent to repair or maintain the business space is deductible. If you paint your home office, the cost is deductible. Your first land-lines into your home for telephone or internet are not deductible, but a second dedicated line into the office and costs associated with that service are deductible.
Indirect expenses: These will probably be your most fruitful business and home-office deductions. Because part of your home qualifies as business property, part of the costs of running it can, if properly documented, move from non-deductible personal expense to business deduction. If your office space takes up 20% of the house, you can deduct 20% of your bills for utilities, homeowners insurance, homeowners association fees, security, and general repairs and maintenance.
Expenses to start up or expand your business: The biggest mistake in deducting expenses to start up or expand your business is failing to make an election to amortize or deduct these expenses in the first year. A paper election that states your intention to amortize the expenses is required as an attachment to the tax return. If not, the expenses become nondeductible until you sell or liquidate the business.
General expenses including those to start up or expand your business: The usual suspects include:
- Promotion, publicity, gifts and advertising. Client gifts are deductible up to only $25 per gift. With respect to advertising, deductions taken for costs that cover multiple-year contracts should be amortized (spread across the contract years).
- Charitable deductions. Save all your receipts contributions of inventory or property. This is another often overlooked area of promotion, publicity and advertising.
- Entertainment and travel expenses. Keep excellent records here, and keep a log of who you met, why, where, when and for what business purpose. 50-percent of meals and entertainment costs are deductible, and none of the costs associated with country club memberships are deductible. Some things that are deductible: business gifts, labor and tips, telephone calls away from the business, taxi and bus fare and parking.
- Seminars and trade shows.
- License fees, as well as regulatory fees, are deductible.
- Professional and legal expenses, commissions and association dues. If the costs are part of startup expenses, amortize the cost over 60 months. Association dues may include a portion for political contributions or lobbying; these are not deductible.
- Telephone and internet. This includes any dedicated services for your business as well as any online computer services related to business. Note: If you use your home or personal cell phone for business, you may only deduct the portion used for business purposes.
- Professional publications (amortized over the subscription period if prepaid) and computer software licensing fees (capitalized and amortized over 60 months unless it has a life of only one year, such as an annual maintenance agreement). Audiotapes and videotapes related to business skills and any business-related magazines and books are deductible.
- Any education, continuing education or professional-certification training that directly pertains to your current business. Education toward a personal interest or a new (not-yet-existing) business is not deductible (but you may be eligible for other non-business deductions for education; consult your tax professional or local IRS office).
- Petty cash funds.
- Shipping and postage.
- Consultant fees.
- Service Fees. For example, credit-card-processing fees, credit-bureau fees and bank-service charges.
- Insurance premiums for the business for one year or less are deductible currently, while excess prepaid premiums are deductible in subsequent years.
- One can fully deduct interest on loans for your business. If you have a loan from a relative, be sure it conforms to IRS rules.
- Deducting rent or depreciating the cost of the space. If you rent the home or apartment where your office is located, one deducts the percentage of rent that is the percentage of space devoted to the business. If you own your home, you depreciate the business part of the house. Figuring the right amount to deduct may initially be complicated, but like figuring the cost-basis in a stock investment, one only has to do it one time and that data can be used as many times as needed in the future.
- Taxes, Social Security and Benefits. State and other taxes incurred in running your business are deductible. Be sure to work with your tax professional and set-aside funds so that there are no end-of-the-year surprises.
- Employee Benefits including retirement plans, health insurance premiums, other insurance (group life and disability coverage) and fringe benefits including profit-sharing paid to employees (tuition assistance, training expenses, etc.) are generally tax deductible business expenses. Solo entrepreneur or business owner with many employees, all retirement plans and contributions (up to a certain limit each year) to qualified tax-advantaged retirement plans (SEP IRA, SIMPLE IRA, 401(k) and similar retirement accounts) are tax deductible.
- Equipment, furniture and supplies. Best to consider with a tax professional as either a direct (deduction) expense or something to amortize over time. Never purchase unnecessary equipment because it is deductible, this is a business inefficiency and will probably just end up costing you money.
- Office supplies. Don’t forget coffee and other beverages, including beverage-service providers.
- Casualty and theft loss.
- Bad debts. This is a “next-year”debt deduction for income previously declared. If the actually non-existent never realized income was not declared when you expected to have it in your coffers, you cannot try to recover it the next filing year.
Home office: If you have a dedicated home office, deduct it. It is not allowed for the space to serve double-duty as a craft studio, home storage, child play space or spare bedroom. To qualify, the space must be exclusive to your business.
You can deduct a portion of rent, utilities, insurance, taxes, maintenance, professional cleaning, depreciation and interest. State tax deductions will vary. If you are eligible for home office deductions, the tax savings can be well worth the additional work required to qualify. Mortgage interest and property taxes are deductible expenses if you qualify for home office deductions. That said, with a home office, one should convert part of those expenses from personal itemized deductions to business deductions, because business expenses reduce self-employment income, as well as reduce your Social-Security tax obligation.
Auto expenses: You may deduct mileage, parking fees and tolls for business use of your car. Most people take the standard mileage rate deduction because the record keeping requirements are less burdensome, but actual expenses often yield a larger deduction. Keep track of the mileage, odometer start and finish for each trip, destination, the starting point and business purpose.
Health insurance: One of the main tax advantages of running, for example, a sole proprietorship, is that you can deduct the cost of health insurance for yourself, spouse and dependents. This deduction can be taken even if one does not regularly itemize deductions. The health insurance deduction is an "above-the-line" deduction, meaning it comes straight off gross income before you reach your adjusted gross income. Other deductions, such as itemized deductions, are "below-the-line" deductions. This deduction is limited and governed by taxable income. For example, if you take a loss on your business, you will not have any health-insurance deduction; and no deductions for any time that you or your spouse worked under contract and were covered by group health from another employer.
5 Overlooked Small-Business Tax Deductions by Steve Nicastro of Nerd Wallet
15 Small-Business Tax Deductions by Karen Price Mueller
The Big List of Business Deductions (excerpt) from Kabbage
Small Business & Self-Employed Tax Center: The Internal Revenue Service
Starting a Business: The Internal Revenue Service