As a small business, you are legally entitled to certain deductions that many small businesses either don’t know about or forego for fear that they might be audited. However, the IRS red flags for audit don’t come from deducting what a small business is entitled to deduct. The IRS may audit a small business when the proper procedures and limits are not followed. Avoiding the entire deduction doesn’t give a small business all the benefits that are allowed by law. If you’re not familiar with small business deductions, it’s a good idea to consult with a tax professional, because if your recordkeeping and support of your deductions doesn’t seem acceptable to the IRS, then you might regret the do-it-yourself approach. Many people during an audit turn to a professional and realize that they would have benefited tremendously had they filled out their tax forms correctly the first time.
Still, it’s good to know what types of deductions there are for a small business. Make sure that you follow the instructions for each deduction and that it is a necessary business expense. It’s important to be careful when deducting expenses, however don’t avoid knowing what you are legally entitled to deduct.
Audit Red Flags
The IRS audits small businesses when they notice math mistakes, the business has a large amount of cash transactions, and if the business comes up in the red at tax time. Many tax professionals suggest that you make sure that all the deductions you take are allowed under the tax code. Abuse of the home office deduction has led the IRS to audit some self-employed entrepreneurs, so heed the requirements. Small businesses that show a big change in income or expenses from previous years should make sure that they have good bookkeeping, because the IRS might audit to understand what happened. The IRS is always on the lookout to make sure that small businesses do not mix business and personal expenses. Additionally, if you use your car for business, be sure that you follow the IRS requirements for claiming all or part of the cost of car-related business expenses. The IRS provides detailed instructions and you can refer to Publication 463 “Travel, Entertainment, Gift, and Car Expenses” so that you don’t miss out on the deduction and still adhere to the rules.
Best Small Business Deductions That Most Companies Can Claim
1) Home-Based Use of Business
Using IRS form 8829 “Expenses for Business Use of Your Home,” a small business can calculate the allowable deduction of home office expenses for their company. The calculations are then shared on Schedule C (Form 1040). The home office deduction is a tax benefit for those small businesses that use a portion of their home for business purposes. It’s essential that you meet IRS requirements. Don’t avoid the deduction altogether thinking that the IRS sees the deduction as a red flag. If applied legitimately and you ensure that you qualify, you can rightfully claim it. Some of the requirements include that the portion of the room that you are claiming as a home office is exclusively used on a regular basis for business purposes, with some exceptions. Review the exceptions. You also have to prove that your home is the principal location where you conduct your business, with some exceptions. Review the exceptions. The IRS provides the official Publication 587 as a great resource to make sure that you have proper guidance.
2) Commercial Credit Loan Interest
Many small businesses take out loans and use credit to finance their business. The interest and carrying charges are fully tax-deductible. Keep good records.
3) Equipment Deductions / Depreciation
If you purchased any equipment as a small business, you are entitled to write off the full cost of some of the assets in the year you buy them. Some assets need to be capitalized, meaning that you are required by the tax code to deduct the cost over a number of years. A small business must determine whether equipment is considered an expense or capital asset by determining the useful lifespan of the equipment. Once that is determined, Section 179 of the tax code permits businesses to expense the entire depreciable basis of equipment in the year of the purchase or take deductions on depreciation for a specific asset over the course of a few years. Check to make sure that you follow the IRS limits on income and equipment deductions.
4) Employee Retirement Savings Contributions
If your small business set up and maintains a retirement plan such as a Simplified Employee Pension (SEP) plan or a Savings Incentive Match Plan for Employees (SIMPLE) plan, you can deduct contributions you make for yourself and your employees. Publication 560 “Retirement Plans for Small Business” is a useful resource to understand which plans allow for employers to make appropriate deductions and deduction limits.
5) State Income Taxes
If your state taxes the gross income of your business, you can deduct that tax on your federal return. As an employer, you can deduct your share of an employee’s employment taxes. You are legally allowed to deduct various federal, state, local and foreign taxes as a business expense. Review Publication 535 “Business Expenses” to see what taxes you can deduct.
6) Professional Organizations
If your business pays dues to stay engaged in professional, business, and civic organizations, then your business is allowed to deduct the dues and subscription costs if the organization has as its principal purpose to help communities rather than provide their members entertainment. Some organizations that the IRS regulations include are public service and civic organizations like Lions, Rotary, and Kiwanis. It also includes dues to Chambers of Commerce or Professional Societies. Most businesses list these as trade association membership fees. The tax code also permits small businesses to deduct subscription costs and dues from professional, technical and trade journals that deal with your business field. Check Publication 529 “Miscellaneous Deductions” for more details.
7) Normal Business Expenses
Businesses can deduct insurance expenses for your business as long as they’re necessary and ordinary. Check Publication 535 “Business Expenses” for a list of different types of insurance that qualify.
8) Legal or Professional Services
If your business requires legal and professional fees, you may be able to deduct them. Check Publication 334 “Tax Guide for Small Business” to see if your specific legal or professional fees would be considered ordinary and necessary expenses directly related to operating your business.