These top ten Tax Deductions for small businesses can benefit every entrepreneur to lessen their taxable income bills. Claim all the deductions that are relevant to your work and business structure.
What Is A Tax Deduction and How Does it Work?
The tax deduction can lower the tax bills through the business expense. Also known as a tax write-off, it was subtracted from the taxable income by the percentage of the highest tax bracket.
You can refer to the lists, requirements, and amounts provided by the Internal Revenue Service (IRS) for all the available deductibles for a small business holder. There are three types of deductions to bring your taxable income down.
a. Standard Deduction
The standard deduction is a base-level amount according to your filing status and income level. It is fixed and easy to claim compared to the other deductions. The automatic tax break does not require any special circumstances or enumeration of the expenses to gather more benefits and deductions. This typically increases each year because of inflation.
Individuals and small businesses are subjected to cuttings from their taxable income, standard tax deduction reduces their overall tax bill with no questions asked. For example, In 2022 a single taxpayer and a married taxpayer filing separate returns are eligible to claim a standard deduction of $12,950. While married couples who filed jointly can claim $25,900. Head of household taxpayers, with dependents and unmarried, can claim $19,400 worth of standard deduction. For 2023, joint filers will increase to $27,700, for heads of household the amount will be $20,800, and $13,850 for single filers and married filing separately.
Taxpayers aged 65 or older, blind or both can have additional standard deductions as stated by the federal income tax system. There is a blindness adjustment for partially or blind people. The tax code’s definition of partially blind is corrected vision no better than 20/200 or a field of vision that is no more than 20 degrees.
b. Itemized Deductions
Itemized deductions need the list of all your qualifying deductions. Unlike the standard deduction, this will be worth all the sum of the specific deductions by claiming it on Schedule A. This “Schedule A” is a separate form to calculate your itemized deductions. The common itemized deductions include:
- Mortgage expense
- Medical and dental expenses
- Personal property taxes
- Casualty losses
- State and local income tax (or sales tax)
- Charitable contributions
- Investment interest expenses
- Student loan interest
- Miscellaneous deductions
If you have substantial expenses, mortgage interest, and charity contributions, you might want to consider itemizing them for some deductions. The standard deduction is simpler and easier to claim but it can cause you money. Calculate the numbers and decide which option will give you a chance to save more.
c. Above-the-line Deductions
You can claim your above-the-line tax deductions regardless of which of the first two deductions wh chose. This is a stand-alone adjustment with its criteria and a free-agent tax break. Eligible taxpayers should follow the rules and limitations to take this in addition to either of the other deductions. Examples of above-the-line deductions are:
- Education Expenses
- Health Insurance premiums
- Self-employment tax
- Personal property taxes
- Retirement Plan Contributions
- Student loan interest
- IRA contributions
- Domestic Production Activities
- Health Savings Accounts and Archer Medical Savings Accounts Contributions
Work with a competent tax preparer to guarantee that your tax deductions are not subjected to any law-breaking. Before you file your taxes remove certain quantities to avoid having less income than the amount that you earned.
How to Calculate and Prepare your Tax Deductions?
Perform calculations on your accounts to help you determine the correct and appropriate kind of tax deductions to take. Choose the one that will save you the most money and time. Regardless of the method, you picked you are mandated to prepare the necessary files before starting.
Refer to your previous pay stub to settle these needed records.
- Most recent pay period income
- Year-to-date income
- Year-to-date federal income tax paid
- State and local income taxes paid
- 401(k) or other employer-sponsored retirement plans
- Health Savings Accounts (HSA), Flexible spending accounts (FSA), or other cafeteria plan contributions
Sort out the documents of your sources of income like scholarship or grants, unemployment compensation, self-employment income, investment income, estimated tax payments, all other forms of taxable income, student loan interest paid (capped at $2,500), educator expenses (capped at $250), and IRA contributions not deducted from your paycheck. Also, prepare the possible data for other deductions for which you may qualify, the following are the top ten tax deductions you can claim as a small business owner.
Top 10 Tax Deductions for your Small Business
1. Startup Costs
Launching a new business venture is exciting and intimidating at the same time. Starting it in the latest tax year will give as much as a $5,000 deduction in the startup expenses. Marketing, training, and travel costs are part of the startup expenses.
The initial investment is very significant to compute the average amount. This is a list of the different types of financial entry barriers you can take into consideration.
Equipment – You need to finance equipment to startup your business and the range depends on the industry and size of the company. To execute creative ideas here are the eight essential business equipment for your small business launching:
- Printer and Shredder
- Computers and Smartphones
- Company Vehicle
- Internet and Communications
- All-in-One Software
- Security Systems
- Specialty Equipment
- Shipping Tools
Think about the goals and vision you set for your business before choosing the appropriate software or property to invest in. Budget any tools for detailing your shop, for expensive equipment you can consider leasing them or applying for a small business loan.
Incorporation fees – A business entity with financial, legal, and tax implications is part of the bases of incorporation and startups. Incorporation fees sustain the company before its active management. If you want to form a Limited Liability Company (LLC) or Limited Liability Partnership (LLP) you need to spend money for organization and expenditures.
Incorporation fees are tax deductible, its startup expenses are any of the following:
- Employee training
- Investigation affiliated with constructing or developing an enterprise.
- Consulting fees
- Charges incurred in examining the feasibility of a business, like market surveys and analysis
- Initiating or setting up an active business.
- Initial advertising
- All activities for proceeds and for rendering profits before the opening of active business, if such payments would be deductible for an existing business.
- Travel costs incurred while locating distributors, suppliers, and buyers for the company’s products and services.
Website – The professionalism of a business reflects on its website. Navigation and display of the products, services, hours, and contact information are the key factors of a good business website. If you are not familiar with computers and not very tech-savvy, you can hire someone to build the site for you.
In 2022, the maximum deduction under Section 179 can be $1.08 million and run down beginning at $2.7 million.
For 2023, you can still deduct 100% of the website hardware expense as long as it does not exceed the limit.
Professional consultants – Legal and professional fees are also eligible for a tax deduction. Working with accountants and bookkeepers to review your contract, tax preparation, and leasing expenses is worth your investment. Attempting to save by the DIY approach is not recommended. Certified public accountants will guide you with the best business structure and legal programs. Tax return preparation will be less time-consuming and confusing with a consultant.
Aside from the mentioned above, here are the other startup costs for a new business: wages to train employees, utilities, opening a facility, and travel costs for securing distributors or suppliers. Taxes for startup costs are more complex like handling the business itself and preparing the accounting books.
2. Self-Employment Taxes
Social Security and Medicare taxes are primarily for individuals who work for themselves. Self-employment tax or SE tax for small business owners can deduct employer-equivalent portions of their adjusted gross income. The rate is 15.3%, 2.9% for Medicare, and 12.4% for social security. For 2022, the first $147,000 of your combined wages, and net earnings are subject to any combination of Social Security. This is part of your self-employment tax or the Social Security tax.
This deduction is only applicable to your income tax and not your net earnings from self-employment or your self-employment tax itself.
How to Pay Self-Employment Tax?
File your self-employment tax using Form 1040 or 1040-SR from Schedule SE. It applies to your net earnings from self-employment of $400 or more and the church employee income of $108.28 or more. The tax rules apply no matter how old the claimant is and if you are already receiving Medicare or Social Security.
A Social Security number (SSN) or an Individual Taxpayer Identification Number (ITIN) are the requirements to claim a self-employment tax. You may need to submit Estimated Taxes quarterly to pay your self-employment tax.
3. Home Office Expenses
Owning a home or renting a place? You can be qualified for a home office deduction whether you own your office or rent it. An office is defined as a room in the house, a partitioned place,e or a separate structure outside. As long as it was for principal, exclusive, and regular business use.
There are two methods to calculate your home office deduction, the simplified method or the actual expenses method.
A quick and simple way to compute your home office deduction. As a business owner, you can subtract $5 from every square foot of your home office. Measure the square feet of your total home office and divide it by the total square feet of your house. The obtained percentage will be multiplied by $5 for your total tax deduction. You can acquire up to 300 square feet.
(square feet of your total home office ÷ the total square feet of your house) x $5 = total home office tax deduction
Actual expenses method
You can save more money with the calculation of the actual expenses. Businessmen with a wider home office (300 square feet more) have this only option to use. You have to track your direct and indirect expenses.
Direct expenses – Direct costs are directly accountable for the home office expenses. These can be fully deducted. Some direct expenses are connected with purchasing the products, shipping them to the market, and manufacturing.
Indirect expenses – Can not be associated directly with the cost object and operating the business. Examples of indirect expenses include:
- Real estate taxes
- legal fees
- business permits
- office expenses
- supervisor salaries
- Security system
- telephone expenses
The formula is similar to the simplified method, the percentage can be calculated by measuring the square feet of the home office and dividing it by the total square feet of your house. You need to fill out tax Form 8829 to settle your total deduction.
4. Advertising and Marketing
It can consume almost 0% to 10% of the total budget. That is the recommended overall marketing charge. You should keep this portion at a minimum. Included in the marketing plan are digital materials like websites, social media accounts, videos, infographics, ebooks, and emails. Another is the physical materials like signage, banners, freebies, and other apparel.
The best thing about technology and the internet is that you can do your advertising and trading for free. Social media platforms and online strategies are much cheaper than the typical marketing technique 20 years ago
5. Retirement Plan Contributions
The annual Retirement Contribution is limited to $20,500 for 2022 and $22,500 for 2023 for 401(k) plans. Traditional and other qualified retirement plans are not included in your taxable income. With the same applicable income tax, you must pay withdrawals and distributions.
Are there any other ways to reduce your taxable income?
Traditional IRA/Other Retirement Accounts are the other options to lessen the income tax charges. Roth IRAs are not deductible but they have longer-term tax benefits. Traditional IRAs can be deducted from your federal income tax amount.
6. Medical Insurance and Premiums
Medical expenses, Insurance premiums, and other Health-related costs are sometimes left out of the deduction list. You can also claim Life insurance and business-related insurance premiums.
Health Savings Account (HSA) – is a tax-advantaged account that is allowed for individuals with high-deductible health plans. This is for dental, prescription drugs, earnings, and distributions used for qualified medical expenses.
Flexible Spending Account (FSA) – this is an employee-established account with tax-free contributions and withdrawals used for medical and dental services.
Other Qualifying Plans – Other qualifying plans can be funded with tax-deductible premiums. A plan like 412(e)(3) is an uncommon benefit plan exclusively funded by life insurance contracts, fixed annuity contracts, or a combination of the two. It can be a substantial deduction for small-business owners with guaranteed income streams and retirement savings.
7. Work-Related Car Use
It’s Tax-Deductible when you use your car for running your business. You should keep the records of your car used to claim the expenses through the mileage rate method or the actual expense method. Both methods can be applied if you qualify for both.
Standard mileage method – are the miles driven for the business. Multiply it by the standard mileage rate. In the first half of 2022, the standard mileage rate was 58.5 cents per mile and in the second half, it increased to 62.5 cents per mile.
This method does not require tracking individual purchases using the saved receipts. Photograph the odometer of the vehicle on New Year’s day to monitor your mileage at the beginning of the tax year. Your mileage log should have the date you drove, the starting and ending odometer readings, the description of the business activity, and the starting and ending times of each trip.
Actual expenses method – Add every money spent on the car operation. Then, multiply this figure by the percentage of the vehicle’s business use. So if the miles you have driven your car were half used for business operation and personal use you should multiply the total car expense by 50%.
For example, the total expense is $10,00: $10,00 x .50 = $5,000
Your business expense is $5,000.
8. Phone and Internet Expenses
If you are a small business entrepreneur you intend to use your cellphone for business. This business usage of your phone can be claimed as a tax deduction. If you spent 40% of your time on the phone on your business, you can legitimately deduct 40% from your phone bill. It is best to get an itemized phone bill to measure and prove to the IRS your separate business and personal use.
What are the conditions for claiming a deduction?
If you do not incur any expenses for the cost of your phone calls, you can not claim a deduction. You have to work out the amount of your phone, data, or internet for both work and private use. You must have a record to prove that the expenses are directly related to earning your income and the money you spent without your employer’s reimbursement.
9. Rent and Repairs
The good side of paying for repairs for your small business is the deductible repair and rent expenses. Materials, supplies, rent and maintenance costs are eligible for tax deductions too. Some rental expenses can be deducted from your tax return after receiving rental income from the rental of a unit.
What are the Records that I Should Keep?
Prepare the financial statements, track the deductible expenses, and monitor the progress of your rental property by keeping these records:
- rental activities (rental income and rental expenses)
- canceled checks or bills
- travel expenses incurred for rental property repairs
- records following the rules in chapter 5 of Publication 463, Travel, Entertainment, Gift, and Car Expenses.
10. Business Interest and Bank Fees
Have you tried applying for a business loan? A business interest expense is charged from availing of business loans used to maintain operations. Like an ordinary business expense, it can be a deduction if the loan qualifies under tax law. Real estate investment companies, certain utilities, and farms CAN NOT apply to this kind of deduction.
The primary focus of these bank fees is its ability for the expenses to be deductible. The loan is a purchase of assets for the business or payment for business expenses. If used for non-business purposes, the deductible interest must be reduced proportionately.
Does a tax deduction mean I get my refund?
Reducing your tax liabilities is not about luck and connections–-it’s the knowledge and skill that you learned. Qualifying for certain deductions for your small business is like winning the lottery. Tax deductions reduce your taxable income with a fixed tax rate. This can be a refund of your withholding.