What is a Tax Deduction?
Last Updated January 17, 2024
A tax deduction, also known as a “tax write-off,” refers to an eligible expense that can be subtracted from your taxable income. By deducting the expense amount from your taxable income, you effectively reduce the amount on which you are required to pay taxes. However, the expense must meet the Internal Revenue Service (IRS) criteria for a tax deduction.
Here is a comprehensive list of deductions commonly available to self-employed businesses organized as sole proprietorships or partnerships. Some are directly related to business operations, while others are personal deductions that small business owners should be mindful of.
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Tax Deduction Benefits
Optimizing your available tax deductions can lead to substantial savings, potentially reducing your tax bill by hundreds or even thousands of dollars. Consider the following example:
Let’s take Joe, a self-employed writer with $60,000 in self-employment income in 2023. Joe is subject to a 15.3% self-employment tax and income tax based on his tax rate. Initially, his tax liability was $13,343.
In early 2023, Joe joined Bench, a bookkeeping service, which identified $6,000 in contractor expenses he was unaware of. These expenses qualify as tax deductions, reducing Joe’s net self-employment income to $54,000.
With $54,000 in taxable self-employment income, Joe’s revised tax liability is $11,830. The additional business expenses saved Joe over $1,500 in taxes. By identifying and leveraging multiple deductions, small business owners like Joe can significantly reduce their taxable income, leading to substantial savings.
Staying Informed on Deductions
For small business owners, staying informed about relevant deductions can be challenging. Many individuals struggle to track deductions throughout the year, often attempting to piece together information at year-end, which can result in missed opportunities for tax write-offs.
This is where effective bookkeeping becomes crucial. To claim deductions successfully, accurate record-keeping and monthly bookkeeping updates are essential. Bench, a bookkeeping service, provides a solution by ensuring that deductions are identified and recorded each month, minimizing tax liability. This proactive approach allows business owners to confidently submit accurate information to their accountants or entrust Bench with both bookkeeping and tax filing responsibilities for a seamless and stress-free tax season.
Top 17 Small Business Tax Deductions
Below is a list of tax-deductible expenses for small businesses. Keep in mind that not all deductions may apply to every business, and it is advisable to consult with a tax advisor or CPA before claiming deductions.
- Advertising and Promotion
- Bank Fees
- Business Meals
- Business Insurance
- Business Interest and Bank Fees
- Business Use of Your Car
- Contract Labor
- Home Office
- Legal and Professional Fees
- Moving Expenses
- Rent Expense
- Salaries and Benefits
- Telephone and Internet Expenses
- Travel Expenses
Let’s delve into each of the 17 small business tax deductions in detail:
Advertising and Promotion:
Eligible Expenses: Costs associated with promoting and advertising your business.
Examples: Designing a business logo, printing business cards or brochures, purchasing ad space in media, launching a website, running social media campaigns, and sponsoring events.
Note: Deductions don’t apply to amounts paid for political lobbying or campaigns.
Eligible Expenses: Fees related to business bank accounts, credit cards, and third-party payment processors.
Examples: Monthly service charges, transfer fees, overdraft fees, and merchant/transaction fees.
Eligible Expenses: 50% deduction for qualifying food and beverage costs directly related to business activities.
Conditions: Expenses must be ordinary, necessary, and not extravagant; the business owner or an employee must be present.
Note: 100% deduction for providing meals to employees and meals at office parties.
Eligible Expenses: Premiums paid for various types of business insurance.
Examples: Property coverage, liability coverage, group health, dental and vision insurance, professional liability, workers compensation, auto insurance for business vehicles, business interruption insurance.
Business Interest and Bank Fees:
Eligible Expenses: Interest paid on business loans or credit cards.
Conditions: Must be legally liable for the debt, and there should be a genuine debtor/creditor relationship.
Business Use of Your Car:
Eligible Expenses: Costs associated with using a vehicle for business purposes.
Methods: Standard mileage rate or actual expense method.
Note: Commuting between home and regular place of business is not deductible.
Eligible Expenses: Fees paid to freelancers or independent contractors for business-related services.
Note: If payments to a contractor exceed $600 in a tax year, a Form 1099-NEC must be provided.
Eligible Expenses: Spreading the costs of business assets over their useful life.
Methods: De minimis safe harbor election, Section 179 deduction, bonus depreciation.
Note: Depreciation rules apply to furniture, equipment, and other business assets.
Eligible Expenses: Costs for education that enhances business skills.
Examples: Classes, seminars, subscriptions to trade publications, and workshops directly related to the business.
Note: Education for a new career or unrelated to the business is not deductible.
Eligible Expenses: Deductions for using part of the home for business purposes.
Methods: Simplified method (deducting $5 per square foot) or standard method (tracking actual expenses).
Conditions: Regular and exclusive use for business activities, and it must be the principal place of business.
Eligible Expenses: Deducting interest paid on loans or credit cards used for business expenses.
Conditions: Legally liable for the debt, both parties intend for the debt to be repaid.
Legal and Professional Fees:
Eligible Expenses: Fees paid to lawyers, accountants, bookkeepers, tax preparers, and online bookkeeping services.
Note: Deduct only the portion related to business, not personal work (e.g., making a will).
Eligible Expenses: Deductions for moving business equipment, supplies, and inventory from one business location to another.
Note: Personal moving expenses are no longer deductible for non-military individuals.
Eligible Expenses: Deducting rental payments for business locations or equipment.
Note: Rent on a personal residence, even with a home office, is not deductible as a business expense.
Salaries and Benefits:
Eligible Expenses: Deducting salaries, benefits, and vacation time paid to employees.
Conditions: Employees must not be sole proprietors, partners, or LLC members; salaries must be reasonable, ordinary, and necessary.
Telephone and Internet Expenses:
Eligible Expenses: Deducting costs of business-related telephone and internet services.
Note: Only the percentage allocable to business use can be deducted if used for both personal and business purposes.
Eligible Expenses: Deductions for ordinary and necessary business travel expenses.
Examples: Transportation costs, meals, lodging, parking, toll fees, and other related expenses.
Conditions: Must be away from the tax home for more than a normal day’s work.
Remember that consulting with a tax advisor or CPA is crucial to ensure eligibility and compliance with specific rules and regulations related to each deduction.
It is crucial to note that some deductions, such as advertising costs, bank fees, and legal fees, are fully deductible, while others, like meals and travel expenses, have specific eligibility criteria.
Additionally, business owners should be aware of personal tax deductions, including charitable contributions, child and dependent care expenses, retirement contributions, and health care expenses. Proper documentation and record-keeping are fundamental to maximizing these deductions and minimizing tax obligations.