The Internal Revenue Service (IRS) offers many opportunities for small businesses to write off various types of business expenses. These tax deductions are designed to make it easier for small businesses to operate and to encourage investment. A tax deduction differs from a tax credit. A deduction is subtracted from taxable income, while a credit is subtracted from the total amount of tax you owe.
Most Business Expenses Can Be Written Off
It's generally accurate to say that the IRS taxes profits rather than income. You can write off the cost of purchasing inventory, paying employees, buying equipment, traveling, entertaining, and even buying gifts. You can also write off the cost of retirement plans, insurance, rental expenses, and business-related education. Limits apply to many of these deductions, though. For example, some deductions are limited to a certain percentage of your taxable income or adjusted gross income.
Two Categories of Deductible Expenses
Deductible expenses are classified as capital expenses or business expenses. Capital expenses are expenditures on property and equipment that will last for at least a year and increase the quality or quantity of your company's products. In most cases, you must gradually deduct the value of capital expenses over the lifetime of the item rather than deducting it all at once in the year of purchase. Non-capital expenses are classified as business expenses, and these expenses must be "ordinary and necessary" to qualify for a deduction. For example, you may be denied a deduction for political lobbying activities or for excessive salaries paid to employees.
Advance Planning Can Save Taxes
There are many ways to structure your business to save tax dollars. For example, you might adjust your purchase of office equipment to comply with the accelerated deduction allowance under Section 179 of the Internal Revenue Code. Working at home as an owner-employee can save you the expense of maintaining an office while allowing you to deduct home office expenses from your personal income taxes. Since legal and professional fees are deductible, you should consider retaining tax lawyers and accountants, who might find ways to save you more in taxes than you spend on their services.
Keep Careful Records to Prepare for an Audit
The IRS may examine your business expense deductions. If you are audited, you may be required to produce detailed documentation of your expenses. You might be taxed on any deduction that you didn't adequately document, and you may be required to pay tax penalties. The home office deduction and high salaries paid to owner-employees of S corporations are red flags with the IRS. Keep original receipts for all purchases and make sure that your business expenses are "ordinary and necessary" as determined by industry norms. Some accounting firms even offer audit insurance to help defray the cost of a tax audit.
A Tax Lawyer Can Help
The law surrounding business tax deductions is complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, please contact a tax lawyer.