As a small business owner, you always keep an eye on your profit margin. One of the ways entrepreneurs can improve their profitability is by reducing their expenses, and tax write-offs are a great way to do that. Keep in mind that while there are several different kinds of tax write-offs available, not all of them will be applicable to your business. Learn what kinds of tax write-offs are applicable to you so you or your tax professional can properly claim them on this upcoming tax season.
What Is a Tax Write-Off?
A tax write-off is a business expense that small businesses can claim as a tax deduction on your tax return. The amount of a tax write-off is deducted from your total earned revenue. This is how the IRS establishes your total taxable income. When you don’t pay income tax on that tax write-off amount, you are able to save money and improve your profitability as a result.
Not all business expenses qualify as a tax write-off. There are specific categories for items that a business can write off. The IRS has deemed that in order to be able to write off a business expense, it needs to be essential to running the business in that particular industry. The business also needs to be a for-profit business in order to be able to write off expenses to reduce the tax bill.
In order to claim a tax write-off, small businesses need to fill out Form 1040, Schedule C. Keep in mind that some write-offs are only applicable to specific types of business structures, like an LLC or sole proprietorship. It’s always best to speak with a small-business tax expert to understand what is applicable to your business.
Common Misconceptions About Tax Write-Offs
It may be tempting to write off as many business expenses as you can so you can get as many tax breaks as possible. However, keep in mind that this is against the rules and can land your business in trouble with the IRS. One of the most common misconceptions is that people think it’s OK to mislabel your personal expenses as business expenses in order to get a tax deduction (such as medical expenses, or a personal credit card). Keep in mind that you can only write off an expense if it is directly related to running your small business.
While home-office space can be deducted as a business expense, it only qualifies if that part of your house is only used for your business. If your home office is also a guest room or houses your sewing machine and ironing board, then it’s likely that it is not a proper tax write-off. Similarly, if you want to deduct your cell phone, you have to be able to prove that the majority of use is for your business.
Another common misconception is that work clothing can be claimed as a tax deduction. In some cases, this is possible, but it’s not always the case. If you can wear the outfit outside of work, such as a nice suit or a skirt, then you cannot write it off. However, if it’s a work-specific outfit, like medical scrubs or a uniform, then you can write it off.
1. Standard Deduction
The IRS offers a standard deduction that can be written off annually. It is designed to reduce your taxable income by a specific amount each year. However, there is a catch: If you use the standard deduction, then you cannot take your small-business deduction or self-employment deduction. As a result, it’s important to find out which deduction is higher for you.
The standard deduction changes each year and depends on how you file your taxes (separately or with a spouse). In 2020, the standard deduction is $12,400 for taxpayers filing individually. The small-business deduction is based on what kind of legal entity you own.
2. Earned Income Tax Credit
If you’ve just started a new business and have a low income, then the earned income tax credit may be a good option for you. While this credit is designed to help low-income families with children, it can also be used together with small-business deductions and credits. In order to be applicable for this deduction, your annual business income needs to be below a set amount, and you also have to have a low amount of investment income.
3. Social Security Payments
Most people who make Social Security payments usually work for an employer. However, if you’re self-employed and running your own small business, you can actually write off up to half of your payment amount. Keep in mind that your deduction amount needs to be taken from your gross income. Plus, you cannot list this type of deduction on your Schedule C.
4. Home-Office Deduction
Many small businesses start from a home office. Even if you have another work location, many entrepreneurs have a home office where they conduct business. If this is the case, you can claim tax benefits for the portion of your home that is used for your home office with the home-office deduction. Essentially, you receive $5 for each square foot of your residence that is used solely for business.
For example, if your home office is 200 square feet, then you can claim up to $1,000 on your annual return. Another way to calculate this write-off is by figuring out the percentage of your home that is used as a home office, which includes your mortgage interest, homeowners' insurance and utilities. Alternatively, if you bought real estate to run your store out of, similar deductions will apply, including for property tax and local taxes.
5. Travel Expenses and Vehicle Expenses
If your business requires you to travel, those expenses can be written off in that tax year. For example, if you have to take a flight to meet with a client or have to drive to meet with a supplier, those expenses can be deducted. Travel expenses can include car rentals, gas, parking, maintenance, tolls, airfare and hotel fees. Keep in mind that you need to have records to show that you were traveling specifically for work.
Track your mileage in your car when you’re traveling for business or when you’re running errands for work-related tasks. You can use the IRS standard mileage rate (which was 58 cents in 2019) to calculate your write-offs, or you can calculate each individual expense separately, such as gas, parking, tolls, etc. If you have an older vehicle that frequently requires repairs, then it may be more cost effective to calculate your expenses rather than using the IRS mileage rate.
6. Medicare Costs
Self-employed people who are on any Medicare plan may be able to qualify for a deduction. Medicare premiums can add up over the course of the year ($100 per month in some cases), so this write-off is definitely worth exploring. This deduction is only applicable if you own a business and applies to federal, state and local income tax, not self-employment tax.
7. Bonus Depreciation
If you need to purchase new capital equipment for your business, such as an expensive refrigerator for the kitchen or a new cash register, you can deduct 100% of your expenses upon purchasing the equipment. However, there are a couple of rules. Depreciation only applies to equipment if it’s purchased and used between 2017 and 2023. Plus, the equipment has to have a life greater than one year, and it needs to be an asset that wears out with use over time.
There are a couple of things that do not qualify for this write-off. For example, you cannot deduct the cost of land, product inventory or air conditioning and heating units.
8. Professional Services
As a small business, you may not have all the expertise you need in house. That’s why from time to time, you may need to hire a consultant to help with accounting, legal issues, marketing and bookkeeping. The fees and expenses for these professional services are deductible. For example, if you hired an accounting firm that specialized in small-business taxes, you could write off the cost of hiring that firm.
9. Office Supplies and Expenses
In many small businesses, office supplies and expenses can rack up a considerable expense. Just think of how much printer paper you’ve had to buy or how many pens, highlighters and sticky notes you’ve gone through. Even if you don’t have a traditional office, you may still have business supplies. For example, a restaurant may have disposable cutlery and napkins. An art studio may have paint and cleaning supplies.
As long as your business supplies are used within the year you purchased them, you can write off their cost. It’s important to track all of these expenses and hold on to the receipts. Keep in mind that if you regularly ship products to your customers, you can also write off the costs for envelopes, postage and shipping services.
10. Client and Employee Entertainment
If you need to wine and dine your clients or have a year-end party to celebrate with your employees, you can write off some of these expenses. You can deduct up to 50% of the cost of client meals as long as you’re discussing business during the event. For example, if the meal was $100, you can deduct $50. At least one employee (which can be you) needs to be present if you’re going to write off the expenses.
You can also write off expenses for office parties, company retreats, office meals and office snacks. However, the expenses cannot be lavish, and you have to be able to show that these expenses were made for your employees. In some cases, you may not be able to deduct the full amount of the expense.
11. Employee Benefits
When you’re running a small business, attracting the best talent can be tricky. In order to compete with larger corporations, you have to be able to offer employees something more than a salary. Employee benefits such as health insurance premiums, health savings account contributions, life insurance, retirement plan contributions, education reimbursement programs, profit sharing and more are all tax-deductible write-offs.
Keep in mind that there are some benefits that you cannot claim as a write-off. If you are listed as the direct or indirect beneficiary of a life insurance policy, then you cannot write off that expense. You also cannot write off the cost of golf clubs or country club fees for employees.
12. Business Advertising and Marketing
Promoting your products and services to your target audience base can be costly. Even running a few ads on Facebook can add up to a few hundred dollars over the course of the campaign. Did you know that all advertising and marketing expenses are tax deductible? These are some of the biggest expenses for small businesses, especially new ones that are starting to grow.
Everything from online and print ads to business cards and flyers can be written off. You can also write off the cost of hiring someone to build you a new website or create a new logo for your business. Just remember, good record keeping and organization is key to tax preparation.
- FreshBooks: What Is a Write-Off? Definition and Examples for Small Businesses
- ShopKeep: The Ultimate List of Small Business Tax Deductions
- Wagepoint: The Comprehensive List of Small Business Tax Deductions
- American Express: 5 Myths About Business Tax Write-Offs
- QuickBooks: Tax Write-Offs: Getting the Most Bang For Your Business's Buck
- Nolo: Deducting Medicare Insurance Payments If You Are Self-Employed
- Business News Daily: Small Business Taxes: What to Expect in 2020
- Investopedia: What You Need to Know About Your 2020 Taxes
Anam Ahmed is a Toronto-based writer and editor with over a decade of experience helping small businesses and entrepreneurs reach new heights. She has experience ghostwriting and editing business books, especially those in the "For Dummies" series, in addition to writing and editing web content for the brand. Anam works as a marketing strategist and copywriter, collaborating with everyone from Fortune 500 companies to start-ups, lifestyle bloggers to professional athletes. As a small business owner herself, she is well-versed in what it takes to run and market a small business. Anam earned an M.A. from the University of Toronto and a B.A.H. from Queen's University. Learn more at www.anamahmed.ca.