One of the easiest ways to make your business more profitable (without working any harder) is to identify all of your expenses and those that are tax-deductible for your small business. These rules also apply to those with self-employment or independent contractor incomes. Keep reading for more information on tax deductions and how to pay fewer taxes on your small business.
I’ve spoken with so many businessowners who had record years in 2020. Being locked at home has caused some of us to spend a lot more time working. One particular new client earned more than a million dollars in revenue and had no idea what he could do to lower his tax liabilities. We were playing catch up for 2020, but luckily, we were able to slash his tax liability in half by fully funding a SEP IRA for him and his husband (Lowering their taxable income by $144,000 with this one move alone). At the same time, we dug through his spending to find as many deductions as he was entitled to use.
That being said, for 2021, we will be able to provide even more massive tax planning value. We are setting up a 401(k) plan and a Cash Balance Pension plan, which will allow this business-owning couple to shelter more than $300,000 in income, per year. From there, we have connected them with a bookkeeper to help make sure valuable tax deductions are not falling through the cracks.
What You Need to Know About Tax Deductions For 2020
In case you didn’t know (many people don’t), simply put, a tax deduction (also often called a “tax write-off”) is an expense that you can deduct from your income to reduce your taxes due. In the most basic terms, you take the amount of the tax-deductible expense and subtract that from your taxable income. For a legitimate tax-deductible expense, your spending has to meet the IRS criteria of a tax deduction.
Keep reading for a relatively comprehensive list of the various categories of tax deductions that are available to you as a business owner. The rules may vary slightly depending on if you are a sole proprietor, S Corp, LLC, partnership, or the owner of a C Corporation. Some of these expenses are relatively obvious as business expenses. Others are more likely spending that you would have done anyway but, potentially, could be eligible for a tax deduction. One example is a cell phone. I don’t know many people who don’t have one. I also don’t know many business owners who never use a cell phone for business activities.
Consult with your amazing financial planner and CPA (or enrolled agent) to find out which of these tax deductions you are eligible to receive. I must also point out that you will need to keep records of your spending to substantiate the tax deductions you wish to take.
The Top Small Business Tax Deduction Categories
Home Office Deduction
With millions of Americans forced to work from home during the Coronavirus, you may be wondering if you qualify for a tax break for the home office deduction. If you are self-employed or a small business owner, the answer could be yes. Assuming you use the space exclusively for business use, and this is your primary place of business. Read this post if you want to know how much, in taxes, the home office deduction could save you.
For those who are employees of another business (not self-employed), you are no longer eligible to benefit from the home office deduction.
Business Use of Car Tax Deduction
Even if you work from home, most business owners at least get some use of their personal vehicles for business purposes. If you use an automobile purely for business uses, you can deduct the vehicle’s entire operating cost. On the other hand, if you use your car for both business and personal driving, you can only deduct the business usage costs.
You have two choices on how to calculate your business use for the car tax deduction. Run the numbers and choose the option that will give you the biggest tax break.
Option 1: Standard Mileage Rate: Track the miles driven and multiply that by each year’s standard mileage rate. For 2020, this is $0.575 per mile driven for business. That drops to $0.56 per mile drive in 2021. So, if you drove 10,000 miles for work in 2020, you would get a tax deduction of $5,750.
Option 2: Actual expense method: For this one, simply track all of your car-related expenses for the year. This will include gas, oil changes, repairs, tires, insurance, registration, and lease payments. Multiply these expenses by the percentage of use that was for business, and you have your tax deduction. So, if you drove 10,000, spent $10,000 running your car for the year, and used the car 80% for business, you would get an $8,000 tax deduction.
Business Retirement Plan Contributions
Paying yourself first is really how many business owners can slash their tax bills. The most common way businesses help their employees (if they have any) save for retirement is by setting up a retirement plan. The business can also make contributions for employees (including the owner).
For 2020, you still have time to set up a SEP IRA. Depending on your income, you may be able to contribute up to $57,000. For businesses that already have an established 401(k) plan, the business can, potentially, contribute 25% of payroll as profit sharing contribution on top of any matching that is part of the 401(k)-plan design.
Many successful businesses are also adding a Cash Balance Pension Plan to the mix. This is one of the ways I can add the maximum value to my business-owner clients. Several of my clients are reducing their taxable income by $300-400,000, per year, by fully funding this amazing pension plan. The tax savings can be huge. They are also providing a wonderful benefit for their loyal employees while staying on track for their own financial freedom goals.
Advertising and Promotion Tax Deductions
Any costs to promote or advertise your business are fully deductible. Some things are obvious, like paying for a website and all the costs that go with it (i.e. web hosting, design, SEO). Others, like printing stationery to thank the client for referrals, may not be as clearly related to your business.
Tax Deductions Legal and Professional Fees
Depending on your business and its legal structure, you may have a wider array of professionals helping you run your business throughout the year. If the legal and professional fees are necessary, and directly related to running your business, they are tax-deductible. These may include but are not limited to attorneys, business coaches, financial planners offering guidance for your business, bookkeepers, and tax experts.
Tax Breaks for Telephone and Internet Expenses
These days, I don’t know of many business owners who could operate without the internet and telephone service. That being said, if internet services and your phone (even cell phone) are integral to running your business, you can deduct costs paid for them.
Deductions for Business Meals
For 2020, business owners can generally deduct 50% of qualifying food and beverage costs. To be eligible for the deduction, the expenses must be an ordinary part of running your business. You may love wining and dining with your best clients, but it is probably a stretch to try and write off a $50,000 bottle of wine. The meals can’t be considered lavish, which does leave some room for interpretation depending on who asks. The business owner or employee must be present at the meal, AKA you can’t just pay for a client (or prospective client for that matter) to take their special someone out to dinner. Well, you can pay for it; you just won’t get a tax deduction for your costs.
When taking business deductions, documentation is key. Keep records of the date and place of each meal, as well as who attended and what the business relationship is.
Insurance for Your Business
If you choose to get insurance for your business, the premiums are tax-deductible. These may include liability coverage, health insurance, workers comp, business interruption insurance, and other items.
Bank Fees Are Tax-Deductible
Having separate bank accounts and credit cards can help make filing your taxes a less stressful process. When your bank or credit card company charges you fees for said accounts, these expenses are tax-deductible. For a business that accepts credit cards, you can also deduct merchant or transaction fees paid.
The Cost of Workers
It is easy to forget about money spent on independent contractors. If you hire a freelancer to spruce up your webpage or someone to fix your computers, track those expenses.
If your independent contractors make more than $600 working for you in any given year, you are required to send them a FORM 1099-NEC by January 31st of the following year.
This is a complicated topic that I could go on about for days, and unless you are a tax-pro, you might get cross-eyed trying to read it. For major purchases, business owners can benefit from a deduction for depreciating assets. Talk with your tax experts to find out if you can benefit more from this tax deduction.
You can get a tax deduction for education expenses that bring value to your business or can help increase your level of expertise. This can also include the cost of continuing education required by your profession. As a Certified Financial Planner™, I have to do countless hours of continuing education each year to maintain this designation.
Unfortunately, this does not include prior expenses incurred for medical school, law school, or any other types of student loans.
You may not know that certain expenses are considered educational thereby making them eligible for the education expense deduction. For example, subscriptions to a trade publication or business seminar related to your specific business are tax-deductible. If you are taking classes or seminars, transportation to and from the events is tax-deductible.
Education costs are fully deductible when they add value to your business and increase your expertise. In order to decide if your class or workshop qualifies, the IRS will look at whether the expense maintains or improves skills that are required in your current business.
Interest Deductions For Small Businesses
You will need to meet a few requirements if you wish to deduct interest paid to a lender or credit card company:
· You must be legally liable for the debt. If your good friend lends you $10,000 and you slowly pay them back, interest wouldn’t be tax-deductible.
· Both you and the lender intend for the debt to be repaid. If a loan is not intended to be paid back, it is simply a gift.
· You and the lender have a true debtor/creditor relationship. Loans between related parties (normally family members) tend to receive the most IRS scrutiny.
Shipping and Postage Expenses for Businesses
During COVID, many more businesses are working virtually and/or selling online. Some businesses will likely spend more than they ever have on shipping and postage. The good news is these expenses are deductible. Business owners can also deduct the expenses of moving equipment between locations and even moving inventory from store to store as well.
You may be thinking of office or warehouse rentals here. But, if you rent equipment for your business, these expenses can also be deducted. Temporary space in a WeWork or similar coworking space is tax-deductible.
Salaries and Benefits
Salaries, benefits, and even vacation time paid to employees are generally tax-deductible. Pretty straightforward here. The cost of running payroll is also tax-deductible.
Taxes and Licenses
Business owners get hit with a slew of additional taxes and fees. This may be on top of licensing to even be in business. Fortunately, business owners big and small can deduct various taxes and licenses related to their businesses. This may include state income taxes, payroll taxes, personal property taxes, real estate taxes paid on business property, sales tax, and business licenses.
Your travel expenses were likely down in 2020, but I would encourage you to take this deduction when eligible. Just make sure to document the business purpose of your travel. I think the IRS may question your two weeks at the Four Seasons on a glorious beach somewhere. Someone reading this likely had a business reason to be there for two weeks, and is entitled to the tax break for costs incurred.
For your trip to qualify as business travel, it must be ordinary, necessary, and away from your tax home. Officially, your tax home is the entire city (or area) in which you conduct business. This is regardless of where you choose to live.
IRS-approved deductible business travel expenses include: travel to and from your destination, using your car while at a business location, parking and toll fees, the cost of taxis or Ubers, and other methods of transportation used on a business trip, meals and lodging, dry cleaning while on a business trip (gotta stay looking good, right?), shipping of baggage and sample or display materials to your destination and other similar ordinary and necessary expenses related to your business travel.
Personal Tax Deductions for Business Owners
The various business deductions listed above is directly attributable to the business. Here are a few other tax deductions that business owners may benefit from on their personal taxes.
Charitable Tax Deductions
For some reason, Sole proprietorships, LLCs, and partnerships are not able to deduct charitable contributions as business expenses. But business owners may be able to claim the deduction on their personal tax returns.
Starting with 2020 returns, taxpayers can claim up to $300 of cash donations even if they don’t itemize them on their personal tax returns. Everyone, please be generous and donate at least $300 to charity this year.
Personal Retirement Contributions
As we mentioned above, business owners can get a tax deduction for contributing to retirement plans on behalf of their employees (which often includes them as the owner). Business owners can also contribute as business employees or make personal contributions to a traditional IRA or Roth IRA (income limits apply).
Preparing to File Your Business Taxes
Running a business is stressful enough. Make your life easier by working with a tax professional to file your taxes. Likewise, please don’t just keep a box of receipts to sort through when filing your taxes. Take the time to set up QuickBooks (or similar software) to track your income and expenses. For those who are too busy to do this, hire a bookkeeper, which can be a lifesaver come tax time, or worse, if you are ever audited. Might I remind you that the costs of bookkeeping software, a tax preparer, and a bookkeeper are all tax-deductible.
Bottom Line for Business Tax Deductions
Take the time to track your income and expenses throughout the year. You can review them later with your fabulous financial planner (if yours isn’t fabulous, find one that is), bookkeeper, and tax pro to make sure you are benefiting from all the tax deductions you are legally entitled to. Being proactive in your tax planning can get you off the hamster wheel of always playing catch up with your back taxes, which many business owners find themselves owing.