For the small business owner, tax season can be stressful, and the prospect of shelling out a load of money to the government is not a pleasant one. That’s why a small business owner's tax deductions are crucial. Here are five tax benefits that are often overlooked by small business owners that can save your business money.
The Internal Revenue Service (IRS) defines deductible expenses as costs that are "ordinary and necessary" to the business. Of course, the agency backs that ambiguous phrase up with a mountain of rules about deductible expenses.
The five below require you to stay tax-conscious throughout the year. Keeping accurate records of your expenses from day to day can mean big savings at tax time.
- If you hold meetings over lunch, you may be able to deduct the cost of your meals.
- If you use your phone or the internet for work, you can deduct the costs of their use for business.
- If you pay for your health insurance, you may be able to deduct the cost of the premiums.
- You can schedule your big business expenditures to maximize the tax break for the expense.
- You can deduct your travel expenses and save the bonus miles for vacations.
Tax Deductions: An Overview
Tax deductions are expenses that you can deduct from your taxable income to reduce the amount of taxes you owe. Many of the most common tax deductions available to individuals were eliminated or capped with the passage of the Tax Cuts and Jobs Act of 2017.
Not so for small business owners, whose taxable income can only be determined by subtracting the costs of doing business from their gross receipts. If you own a small business, are self-employed, or derive income from a limited liability company (LLC), tracking your business costs to deduct them from your income is still critical to your success.
Some of those deductible costs are obvious, such as office rent, business equipment, staff salaries, and business insurance, while some require meticulous record-keeping and receipts, but you may find the effort well worth it when it's tax time.
How Tax Reform Changed Small Business Taxes
The 2017 tax reform act made one very significant change to the way small businesses pay taxes. It allows for qualified small businesses to apply a 20% deduction of their income off the top. That is, taxes will be applied to the filer's business income minus 20%.
This deduction, known as 199A, can be taken regardless of whether the business income is earned by a self-employed individual, a sole proprietorship, LLC, S-corporation, or a partnership.
It can be used by eligible filers regardless of whether they take the standard deduction or itemize deductions.
For tax year 2023, the full deduction is available for filers with taxable income under $182,500 for single filers or $364,200 for joint filers.
1. Write Off Lunch Meetings
If you often have working lunches, you might be able to deduct 50% of meal expenses.
If you meet with partners, employees, or business contacts, consider meeting over lunch. As long as the dining expenses are reasonable, you are allowed to deduct 50% of meal costs when eating with business partners and employees while conducting business operations.
So, if you buy lunch every day and spend around $8, you can deduct $4. If you do the math, that amounts to over $1,000 a year in claimable deductions.
Struggling to keep track of your business expenses? Accounting software is deductible, too, if it is used for your business.
2. Use Your Cellphone and the Internet for Business
When using the phone and internet to run your business, you can deduct these expenses. However, if you use the phone and internet for a mix of work and personal reasons, you can only write off the percentage of the cost that goes toward your business use.
3. Deduct Your Healthcare Premiums
If you have an individual health plan (not a group plan) and pay your healthcare premiums out-of-pocket without tax breaks or subsidies, you may be able to claim those premiums as an income tax deduction if you are a sole proprietor, a partner in a partnership or an LLC, or a shareholder in an S corporation who owns more than 2% of company stock.
Let’s say you are a sole proprietor and your business and personal income totaled $60,000 for the year. Your state and federal income tax obligations are around 30%. If you spent $10,000 a year on health insurance premiums for you and your family, you can deduct that cost. Your taxable income will be $50,000 instead of $60,000, saving you about $3,000 in total income tax payments.
Variations on this Deduction
As a business owner meeting the above criteria, you can claim a $10,000 income tax break but not a break from the self-employment tax, which would remain at $60,000 in taxable income. (Small businesses pay both.)
However, if your spouse is an employee of your company, you can get both. You can purchase a plan in your spouse's name (not in the name of the business) that covers the two of you and your dependents. Since this person is both an employee and your spouse, you can deduct the full $10,000 in payments from both your business income tax and your self-employment tax, assuming you file jointly.
In this scenario, you could save $3,000 on income tax and an additional $1,530 in self-employment tax, for a total savings of $4,530.
4. Plan Your Big Expenditures
Depending on your taxable income, your tax bracket can vary significantly. If your company is a limited liability company (LLC) that means that you pay taxes on your share of the profits.
Several weeks away from the end of the business year, you check your taxable income and find that it is about $100,000 so far, at the 24% tax bracket for 2023.
If you purchase new equipment with an estimated cost of $20,000, it will reduce your taxable income and, most likely, your tax bracket to 22%. If you schedule high-end purchases wisely, you can maximize your deductions and save money every year.
5. Deduct Your Travel Costs
Many business owners rack up points on their travel miles cards so that they can save later on by using the miles for business flights. This is a mistake. Business travel costs are fully deductible as a business expense. Personal travel costs are not.
The wiser course is to save the frequent flyer points for vacation travel and take the full deduction for the cost of your business trips.
What Can You Write Off on Taxes With a Limited Liability Company (LLC)?
If you have income from an LLC, you are entitled to deduct your expenses like any business.
A limited liability company (LLC) can pass all of its profits on to its partners so that the partners, not the LLC, owe all taxes. It's not required to be set up that way but most are, in order to avoid the dread "double taxation" of both the company and its partners.
Depending upon how the LLC is structured at the time it is created, the IRS will treat the profits as the income of a corporation, a partnership, or an individual partner.
What Can You Write Off as a Business Expense in 2022?
As you can imagine, the answer could fill a shelf of books. In short, the IRS defines deductible business expenses as "ordinary and necessary" costs of doing business.
It splits these into a couple of broad categories, including the cost of goods sold (raw materials, freight, storage, labor, and factory overhead), and capital expenses, including startup costs, business assets, and improvements.
Breaking it down a bit further, some deductible expenses include your business rent, salaries, costs of travel, telephone and internet costs, legal fees, advertising and marketing costs, and interest and fees on loans.
Don't forget that big change since the 2018 tax year, the 20% deduction from business income for businesses that qualify.
How Much Can a Small Business Make Before Paying Taxes?
You don't owe tax on income under $400 for the year. This is true whether you're selling your old stuff on eBay or running a major corporation.
Can I Write Off My Car as a Business Expense?
Yes. If you use a vehicle solely for business, all of its operating costs are deductible.
If you use the vehicle for both personal and business use, only costs incurred while doing business are deductible.
This one is a real bear for recordkeeping. There are two ways to calculate the expense, one of which is less onerous than the other:
- You can take the standard deduction, which is 62.5 cents per mile for the final six months of the 2022 tax year. You need to track your mileage when using the vehicle for business. Multiply the standard deduction by the percentage of your total mileage that was devoted to business purposes during the year.
- You can use the actual expense method, which requires you to track all of the costs of business use of the car, including lease payments, gas, oil, repairs, insurance, and registration fees. Add the costs, then multiply the total by the percentage of your mileage for the year that was devoted to business.
The Bottom Line
The tax reform measure that did away with many deductions for individuals did not change the fact that business owners must deduct their expenses from their proceeds in order to calculate their taxable income.
"Ordinary and necessary" costs of doing business are deductible, to quote the IRS' own rule of thumb.
It requires meticulous record-keeping to calculate your costs and to prove their accuracy if an audit makes that necessary. You can even take it another step and schedule your major business expenditures to your best tax advantage.
Disclaimer: Consider consulting a tax professional about allowable deductions for your small business.