Businesses can reduce their tax liability with deductions and credits. The IRS allows businesses to deduct expenses that are considered ordinary and necessary for that line of business, and it provides credits to encourage specific business activities. Deductions reduce the amount of income on which a company must pay tax, while credits directly reduce a company's tax liability. In other words, a deduction might mean that a company pays tax on $750,000 instead of $1,000,000; a credit might mean that a company can subtract $50,000 from its $250,000 tax bill.

Some common business deductions and credits include the following:

Cost of Goods Sold: The amount spent to purchase inventory, including products purchased for resale, raw materials, freight, storage, labor and factory overhead. Indirect costs such as rent, interest and administrative costs must be capitalized.

Capital Expenses: Major expenses for ongoing business assets, including startup costs and improvements, must be capitalized. However, up to $5,000 in startup costs can be deducted in the year the business is opened.


Rent:
The cost of leasing a place of business is tax deductible.

Interest:
The cost of borrowing money for business activities can be deducted.

Employees' Pay:
The salaries and wages paid to employees are tax deductible. So are retirement contributions for employees, directors and officers.

Taxes:
Business taxes paid to state, local and foreign tax authorities are tax deductible.

Insurance:
Premiums for business insurance such as property, casualty and liability insurance are tax deductible.


IRS Publication 535, Business Expenses, provides more detail about tax deductible business expenses.

Source: IRS Offical Website

Credits
The IRS offers various tax credits for business activities it wants to promote. These include research, oil recovery, reforestation, starting a pension plan, providing low-income housing, employing a member of a targeted group such as veterans or ex-felons, providing employment in an urban empowerment zone, and a number of other activities. All qualifying credits are tallied up and claimed on General Business Tax Credit Form 3800.

For further reading, see Give Your Taxes Some Credit, Starting A Small Business: Taxes, The Impact Of U.S. Corporate Taxation On Investment Decisions And CFC Transfer Pricing and Understanding The U.S. Tax Withholding System.

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