Tax deductions are the small business owner’s best friend. They mean more money in your pocket. In fact, it can be the difference between making and losing money on your business.
But deductions don’t fall out of the sky. You need to understand what you can deduct and claim your deductions when you file your taxes. The IRS won’t do it for you.
What is a tax deduction?
A tax deduction (also called a tax write-off) is an amount of money you may subtract from your gross income (all the money you make) to determine your taxable income (the amount on which you must pay tax). The more deductions you have, the lower your taxable income will be, and the less tax you will have to pay.
The federal income tax law recognizes that you must spend money to make money. Virtually every business, however small, incurs some expenses.
Even someone with a low overhead business (such as a freelance writer) must buy computer equipment and office supplies. Some incur substantial expenses, even exceeding their income.
You are not legally required to pay tax on every dollar your business takes in (your gross business income). Instead, you owe tax only on the amount left over after you subtract your business’s deductible expenses from your gross income. This remaining amount is your net profit.
Although some tax deduction calculations can get a bit complicated, the basic math is simple: The more deductions you take, the lower your net profit will be, and the less tax you will have to pay.
How much is a tax deduction worth?
Most taxpayers, even sophisticated business people, don’t fully appreciate just how much money they can save with tax deductions. Only part of any deduction ends up back in your pocket as money saved.
Because a deduction represents income on which you don’t have to pay tax, the value of any deduction is the amount of tax you would have had to pay on that income had you not deducted it. So a deduction of $1,000 won’t save you $1,000—it will save you whatever you would otherwise have had to pay a tax on that $1,000 of income.
For example, if you make $80,000, you’d have to pay federal income tax at a top rate of 22 percent, plus 15.3 percent in Social Security and Medicare taxes, plus state income taxes in most states that average about 6 percent. That adds up to a whopping 43.3 percent of your income getting taxed.
Thus, at this income level, a deduction saves you 43.3 percent in taxes. For example, if you buy a $1,000 computer for your business and you deduct the expense, you save about $433 in total taxes.
In effect, the government is paying for almost half of your business expenses. This is why it’s so important to know all the business deductions you can legally take—and to take advantage of every one.
Top ten small business tax deductions
Here are the top ten tax deductions all small business owners need to know. You may not be able to take all of these deductions every year. But you’ll likely qualify for quite a few of them.
1. Car deductions
The single most claimed tax deduction for the small businesses are car and truck expenses. Most driving you do for your business is tax deductible. But there is one exception: You can’t deduct the cost of commuting to and from work.
If you like recordkeeping, you can keep track of all your car expenses to figure your annual deduction. But, if you’d rather not keep track of how much you spend for gas, oil, repairs, car washes and so forth, you can use the standard mileage rate. When you use the standard rate, you only need to keep track of how many miles you drive for business, not how much you spend on your car. For 2019, the standard mileage rate is 58 cents per mile.
2. Office expenses
The amounts you spend on your business office are deductible business expenses. For example, you may deduct the cost of rent and utilities for an outside office or other workspaces.
But, if like millions of small business people, you work at home, you may be able to deduct the cost of your home office. This deduction is particularly valuable if you are a renter because it enables you to deduct a portion of your monthly rent, a sizable expense that is ordinarily not deductible.
3. Business travel
You may also deduct your expenses when you go out of town for business. These include airfare or other transportation costs and hotel or other lodging expenses. But, you may only deduct 50 percent of the cost of meals when you travel on business.
4. Business property:
There are special rules for deducting tangible personal property for your business that will last more than one year—for example, a computer. In the past, you had to deduct such items over many years.
But, due to recent changes to the tax laws, you can usually deduct such items in a single year. You can do this by using 100% bonus depreciation (in effect through 2022), the Section 179 deduction, or the de minimis safe harbor (applicable to property that costs $2,500 or less).
This change in tax law enables you to get a significant deduction in a single year rather than spreading it out over several years.
5. Rent for equipment and tools:
Many business people don’t buy expensive equipment, vehicles, or tools—they rent them instead. The rent you pay for property you use for your business is fully deductible as a business expense.
6. Supplies
Supplies are business items that you use up in less than one year. They include everything from paperclips to postage stamps.
7. Legal and professional services
You can deduct fees that you pay to attorneys, accountants, consultants, and other professionals if the charges are for work related to your business.
However, legal and professional fees that you pay for personal purposes generally are not deductible. For example, you can’t deduct the legal fees you incur if you get divorced, or you sue someone for a traffic accident injury. Nor are the costs that you pay to write your will deductible, even if the will covers business property that you own.
8. Insurance
Insurance you buy just for your business is deductible—for example, business liability insurance or insurance for business property. If you have a home office, you may deduct a portion of your homeowners insurance. Self-employed people are also allowed to deduct 100% of their health insurance premiums from their income taxes.
9. Business start-up expenses:
If you are not yet in business but are thinking about starting one, you don’t get any deductions. However, if you formally launch the business, many of the start-up expenses you incurred are deductible over the first 60 months you are in business.
Such expenses may include including research; advertising; travel expenses for finding a suitable business location; and operating expenses incurred before the business begins, such as rent, telephone, utilities, office supplies, and repairs.
10. Pass-through deduction:
Most small business owners run as pass-through businesses—that is, it operates as a:
- Sole proprietorship (a one-owner business in which the owner personally owns all the business assets)
- Partnership
- S corporation
- Limited liability company (LLC), or
- Limited liability partnership (LLP).
The Tax Cuts and Jobs Act created a brand new deduction for owners of such pass-through businesses: They may deduct an amount up to 20 percent of their net income from the business. This amount is in addition to all their other business deductions. The pass-through deduction is a personal deduction pass-through owners can take on their returns whether or not they itemize.
This deduction began on Jan. 1, 2018, and will end Dec. 31, 2025.
