Tips • April 6, 2022
Small Business Tax Deductions
Organizing your expenses at tax time can feel like one of the most complex and frustrating parts of being a small business owner.
You have to sort out which expenses are considered tax-deductible for your business’ income, and follow the proper methods for claiming them. Otherwise, you risk them being rejected as inapplicable – or worse, being audited if you don’t have enough evidence to back up your claims.
The good news is that the majority of the expenses you’re incurring for your business are likely tax-deductible.
According to the Internal Revenue Service, anything that’s an ordinary expense for the purpose of generating sales, and/or is a necessary part of your business activities, can be considered a business expense. These are tax-deductible.
While that sounds like a broad explanation, the truth is that there are no firm rules by the IRS for what constitutes a valid expense to claim. Because the rules are so open, a little guidance and direction can go a long way towards making sure that you’re on the right track.
Previously, we offered a comprehensive guide to some of the more common expenses that a business can write off, based on your company’s current needs. Whether you’re just starting off, trying to expand, working from home, or renting commercial space, it doesn’t matter.
Regardless of the format of your business, you’ll still have operating costs and expenses, and you may even have some eligible deductions that other business owners tend to overlook.
For the purposes of this guide, we’ll be focusing on small businesses. We’ll show you how you can manage your financial reporting, and which expenses you shouldn’t overlook. This way, when tax time comes, you can turn all these expenses into a valuable rebate that you can reinvest back into your business.
The Rules of Deductions
As we mentioned, there are no definitive rules about what you can and cannot claim as a business deduction. However, there are some general guidelines to follow. To claim something as part of your business expenses, the item needs to be:
- An expense that is ordinary, common, and accepted in your particular industry.
- An expense that is helpful and appropriate for your business, and that you consider necessary. It doesn’t have to be indispensable, but it should help in generating revenue and sales.
With that said, it’s a good idea to write off as much as possible. One of the easiest ways to make your business a bit more profitable is by reducing your taxable income.
The rules differ slightly depending on whether you’re a sole proprietor, an S Corp, an LLC, a partnership, or the owner of a C Corp. You’ll want to make sure you’re accounting for everything.
Finding the Value in Your Tax Deductions
The majority of your expenses, such as operating costs or office supplies, will be easy to identify. You may have other expenses that are required for business purposes or generating sales, which are tax-deductible as well.
These could be direct costs like software required for running your corporation, or indirect costs like the cost of transportation incurred from traveling to meet with clients or vendors.
The trick is to find a way to keep track of everything and organize expenses into groups. This will allow you to give an accurate record to the IRS and should allow you to be approved on any expense that qualifies.
You definitely don’t want to leave out something important because you weren’t aware that you could claim it.
Tools That Can Help
Like with many things in the business world (and in life), preparation often leads to success. In case of an audit or a tax deadline, nothing is worse than scrambling to reconcile invoices, track receipts, and organize all your business expenses at the last minute.
That’s why one of the very first things every small business needs is trustworthy accounting software for your financial records. Not only will this assist with accounts payable and receivable, but it will help prepare you for tax season, by grouping and organizing your expenses.
As a small business, a lot of the SaaS accounting tools available are plug-n-play right out of the box – there is often little to no customization required.
Once you’re familiar with a tool, it’s easier to track the industry-specific categories or create your own that you can use to organize your deductions. The best part is that you can expense the accounting software as part of your operating costs as well.
Depending on your industry and number of employees, there’s a wide array of tools that can help. They offer ways to integrate with third-party applications, such as POS systems and eCommerce platforms. Some examples include:
- QuickBooks Online: This is one of the best-known and most trusted accounting software systems. The majority of small business accounting professionals rely on it. It’s cloud-based and has an intuitive mobile app, so you can stay organized anywhere. There are also training resources available along with an easy-to-use dashboard that keeps you informed.
- QuickBooks Self Employed: QuickBooks also offers an option for part-time freelancers, solopreneurs, and independent contractors, who want to track expenses and income. It’s fantastic for tracking mileage and delineating between business and personal expenses.
- Xero: Xero is best geared towards micro-businesses that need something very simple. It’s clean, mobile/cloud-oriented, integrates with third-party payroll applications, and works with online payment systems such as Stripe.
- FreshBooks: If you’re operating a service-based small business, then invoicing is crucial for your success. FreshBooks allows you to easily create and manage invoices, as well as maintain your bookkeeping and financial reporting. It’s also useful if you need to send any proposals/estimates, request a deposit, track time, or collect retainers.
- Wave: Wave’s best feature is that it’s free for accounting, invoicing, and receipt scanning, using a mobile app. It’s simple and clean, and if you need more functionality, there are tiered subscription levels that you can pay to access.
Accounting software is only half the battle. You’ll also need something to track your expenses on the go, so you can maintain accurate records and avoid missing anything that’s eligible to claim on your income tax return.
This will save you from uncrumpling and deciphering old receipts, or endlessly scrolling through months of bank charges, trying to figure out where you spent your money.
Instead, look for an app that tracks receipts and office expenses. These apps typically take a picture of your receipts using something called Optical Character Recognition (OCR). The app will scan it, extract the details, and categorize the information with your accounting software of choice.
Some popular apps include:
- NeatReceipts: Neat can group your receipts by category, and extract the pertinent information from them. It also integrates with TurboTax for easy filing.
- Receipts by Wave: This app syncs seamlessly if you’re using Wave’s software for your accounting. It can also convert your receipts into digital data via OCR, which makes it easier to keep track of your receipts on the go. Plus, it organizes the receipts neatly into categories for your business tax return.
- Smart Receipts: This app is geared more towards business travel expenses, such as the cost of meals and business mileage.
Don’t Forget to Include These Expenses
While we’ve got a comprehensive list of expenses you should be keeping track of, there are a few often-overlooked deductions that need to be highlighted. These include:
Home office deductions - Any commercial space that you’re leasing or renting is an operating cost, and is, therefore, eligible for deduction. But what about your home office? If your home office is used exclusively for business use, you can include it in your financial reporting.
The percentage of bills you can claim as a tax credit (i.e., insurance costs, property taxes, telephone service, etc.), depends on the square footage of your home office space, in relation to your entire home.
Using your personal car for business - Even if you’re a business owner working from home, at some point you’re going to use your personal car for a business trip. If your car is purely for business, then all of the operating costs are eligible for tax purposes. If you’re using it for both business and personal use, then you can only claim the percentage that’s being used for the business.
There are two ways to go about this:
- Standard Mileage Rate: This is the miles driven multiplied by the year’s standard mileage rate. For example, 2021’s standard mileage rate was $0.56. If you drove 10,000 miles during this year, then you’re eligible for a tax deduction of $5,600 in this year’s filing.
- Actual Expense Method: Another option is to track all of your car-related expenses (i.e., gas, oil changes, repairs, tires, insurance policy, registration, lease payments, etc.) and multiply by the percentage used for the business. So, if you spent $10,000 on your car this year, and 75% of it was for work, then you’re eligible for a $7,500 deduction.
Business retirement plan contributions - By paying yourself first, you’re actually cutting into your tax bill. Therefore, helping your employees (if you have them) save for their retirement, can reduce your taxable income through your contributions. Plus, it’s a good business practice, and your employees will appreciate it too.
Advertising and marketing - Anything you spend on promoting your business is fully deductible. This means your website, any cost of advertising, printing, etc. are all deductible business expenses.
Rental expenses - Not every small business owns a permanent physical location, and not every entrepreneur works from home. But if you rent commercial space, you can deduct the cost. If you rent any business equipment or work in a co-working space, such as WeWork, those are deductible expenses too.
These deductible business expenses are all great, but they’re also just the tip of the iceberg. Check out the 39 Business You Need to Track, if you’d like to get the most out of your returns.