Categorizing Your Deductible Business Expenses Made Easy
Every business has expenses. When it comes to taxes, some of these can be deducted fully, others can be deducted only by a certain percentage or certain amount, and others can’t be deducted at all.
One common mistake most small business owners make is to not claim business expenses that are deductible, and/or (more commonly) claim expenses that are not deductible.
If the business uses an accountant to file its year-end taxes, these mistakes are typically found, and can be corrected. If the business does its own filing, it may be the IRS that finds these mistakes, disallows the deductions, and increases the tax burden of that business for that year. (In addition, if you have to pay interest on the amount of money you owed the IRS but did not pay, that amount won’t be deductible, either!)
That’s why it pays to have a tax professional either help you set up your expense categories when you first start your business, or “audit” your expense categories during a consultation to ensure that mistakes aren’t being made.
What is a Business Expense?
The IRS says that a business expense is “anything that incurs a cost in order to carry on a trade or business.”
For an expense to be deductible, it must be “ordinary and necessary.”
If you have a dry-cleaning business, it would not be “ordinary” for you to insist that your employees wear a hard hat while on the job. Nor would it be “necessary.” If you have a construction business, on the other hand, it is not only “ordinary” for you to supply your employee with a hard hat, but it would also be “necessary” in order to be in compliance with federal rules and regulations.
What Business Expenses Can You Deduct?
All expenses are divided into categories. By making sure you place your expenses into the appropriate category during book-keeping, you’ll make it a lot easier for you or your accountant to do your year-end taxes.
Here’s a list of the most common business expense categories:
Advertising: Any materials you have created to market your business such as flyers, newsletters, trade-shows, PR firm costs, website creation, SEO optimization and so on.
Bank fees: You can’t deduce interest on loans, but you can deduct maintenance charges, ACH fees, and even overdraft charges from your business account.
Car expenses: If it’s necessary for your employees to travel frequently on “official” business, you can deduct the expenses of operating the vehicle(s) such as gas and oil purchases and depreciation. Note that your employees can only use the car for official business. (The cost of the vehicle itself is no longer deductible.)
Cost of goods sold: If you are a manufacturer, any raw materials you purchase, as well as packing and shipping costs, are deductible.
Donations: If you donate money to an event and receive something in return – ad space in a program for example – the expense is deductible. If you receive nothing “in kind”, it is not deductible as a business expense.
Employee Wages: Salaries, commissions and bonuses paid to employees are deductible.
Entertainment: Take a client and his or her spouse out to dinner, and you can deduct 50% of the cost of the meal and tip.
Office Supplies: Cost of business computers and printers can be deducted. Envelopes and postage for business letters are categorized under office expenses, not cost of goods sold (where shipping costs on products are categorized).
Office Expenses: Electricity to run an air conditioner is deductible, as is the cost of heating oil, and water and sewer fees.
Pension plans: The contributions you make to your employees retirement plans, such as their 401(k) or Keogh plans are deductible.
Professional Services: You can deduct the cost of fees paid to attorneys, accountants and tax preparers. (So there’s no reason not to engage professional services in this regard!)
Examples of expenses that are not deductible
Clothing for work. Since business suits are suitable to be worn anywhere, their cost is not deductible. Uniforms – for example security guard uniforms – would be deductible.
Commuting. The expense of driving to and from work are not deductible.
Commuting costs. If you reimburse your employees for parking garages or bus/train passes, those costs are not deductible.
Gifts. The cost of a gift to a business associate, customer or vender is capped at $25. You can certainly give more, but anything above $25 is not deductible.
Networking. Meeting people at country clubs or by joining service clubs is an idea way to network, nevertheless the dues for belonging to these organizations is not deductible.
Business Size and Business Deductions
Sole proprietors and independent contractors file Form 1040 or 1040-SR, and will use Schedule C to report their yearly income or loss.
C corporations will use Schedule M-1 of Form 1120. S corporations will use Form 1120S. Partnerships will use form 1065.
The size of the corporation also depends on what forms can be used. Schedule M-3 or Schedule M-1 are forms for large entities that the small and medium-sized businesses do not have to concern themselves with.
Considering that underpaying business taxes can result in extra money paid, and interest due on that money that wasn’t paid on time, not to mention fines, it’s important to file one’s taxes correctly the first time.
A professional tax specialist can help the small- and medium-sized business have peace of mind each time the end of the fiscal year comes around.