A common question we hear from entrepreneurs and small business owners goes as follows:
What can I claim as business deductions?
The reason for this question is simple – generally speaking, the more that can be claimed as business expenses, the lower the net income of the business, and the lower the resultant income (and self-employment) taxes.
The IRS indicates that in order to be deductible, a business expenditure must be both ordinary as well as helpful and appropriate. An expenditure is ordinary if it is common and accepted in your business. Here are a few examples of typical deductible expenses:
- Contract labor
- Business insurance
- Legal and professional fees
- Office supplies
- Meals and entertainment
While you may have had expenses that could be categorized as one of these typical deductible expenses, that doesn’t necessarily mean that your expense is deductible. To the extent that those expenses are personal, they are not deductible. For example, if you borrowed money and used 70% of the money for business and the other 30% on gifts for your significant other, you could only deduct 70% of the interest paid on the loan.
If you’re having difficulty discerning whether or not a particular expense should be deductible, ask yourself the following:
If not for the business, would I still pay for this expense?
If you would not be willing to pay for something except for the benefit it provides to your business, then chances are it would qualify as both a helpful and appropriate business expense. If you would be willing to pay for something even if you didn’t have the business, then it probably is not an appropriate business expense.
Another important consideration as to whether an expense is deductible is whether or not it qualifies as a capital expenditure. The most common capital expenditures in small businesses are assets that you will use over time – software, computers, furniture, fixtures, equipment, etc. These costs are not considered business expenses, and are not deducted in the same way. Instead of being deducted in the year of acquisition, capital expenditures are depreciated over a set period of time – 3 years for software, 5 years for computers, 7 years for furniture, fixtures, and equipment, etc.
Section 179 of the tax code does give small business owners some immediate relief for capitalized costs. Rather than slowly depreciating the cost of the capital assets over 3+ years, Section 179 allows you to deduct the full cost of the assets in the first year they are placed in service, subject to some limitations.
We can help you evaluate your current and planned expenses to help make sure that you get the best legal tax treatment. There’s no reason for you to have to struggle with that age-old question:
To Deduct or Not To Deduct?