A business expense is a cost that comes with operating your business. Within that range of costs you will have deductible expenses–expenses which are eligible for tax deductions. It is important for all businesses to carefully keep track of their deductible expenses for tax purposes, but it’s even more critical for small businesses.
Small businesses pay 21% in federal taxes, and 44 states tack another 4-12% on top of that. That’s a significant portion of your revenue. Over 50% of small business owners feel they are paying too much in taxes, and they’re probably right. Taking advantage of established deductible business expenses can save your business thousands or even tens of thousands of dollars every single year.
What business expenses can you deduct?
Deductible expenses are defined by the IRS as expenses that are ordinary and necessary.
- Ordinary expense: Common and accepted in your trade or business
- Necessary expense: Helpful or appropriate for your trade or business
A deductible business expense may fall under these two categories, ordinary or necessary, are eligible to be deducted when you file yearly taxes. Deductible expenses are things you will already be purchasing or spending money on, but you can take advantage of these expenses for tax credits. These tax write-offs might be total, partial, or applied over time, and come in all forms of business expenses.
Although it can mean more careful tracking and more detailed tax filings, the financial benefits for your business can be immense. Here are a few of the most common areas for business expenses that are tax deductible:
7 common deductible business expenses
- Mileage and vehicle expenses
- Entertainment expenses
- Rent and utilities
- Marketing expenses
- Employee pay and benefits
- Miscellaneous or general office expenses
Mileage & vehicle expenses
Annually, Americans take more than 400 million business trips every year and 81% of trips are taken by vehicle. The IRS Standard Mileage rate for 2020 is 57.5 cents for every business mile driven. Although a daily commute is not considered a travel expense, logged miles can be claimed as a tax deduction when the employee travels for business trips or for local transportation for business purposes and requires reimbursements. This is the standard expense method used for expensable business travel. You can also deduct your vehicle usage by taking the cost of the vehicle and taking the percentage of the time you used the vehicle for work purposes, which is considered the actual expense method.
Actual expense method example
When using the actual expense method you’ll add up all the expenses for your vehicle that year (miles, cost to purchase, oil changes, etc.) and multiply that total number by the amount of time you used the vehicle for business purposes. For example, if you paid $5,000 for your vehicle and determined you used it 20% of the time you could claim $1,000 as a deduction.
Standard expense method example
You can also use the standard expense method, which is less detailed and much easier to calculate, so long as you track mileage. To discover this number you need to track your miles from the beginning to the end of the calendar year and multiply by the credited monetary amount (57.5 cents for 2020). For example, if you drove 2,000 miles for work you would deduct $1,150 (2,000 X 0.575).
It’s imperative to keep a detailed record of the mileage, trips and gas usage you use on work related travel to accurately determine the amount of time you used your vehicle for work purposes, since documentation will be key for filing this deduction and in the event of an audit. The purchase of a company car can also be deducted if it’s to be used solely for business purposes.
It is very common for business owners to incur a meal expense when taking clients and employees out for a business meal. Business meal expenses fall under the umbrella of entertainment. Entertainment expenses can be tax deductible if they are associated with business operations and serve a specific business purpose. You will get either a 50% deduction or a 100% deduction depending on the entertainment expense. For holiday parties, meals provided to employees or meals available to the public, can qualify for a 100% deduction (as long as the parties aren’t excessively extravagant). If you’re taking a client to lunch, attending a business seminar, or eating directly with stockholders you can get a 50% deduction on associated costs.
Many business owners want to connect with their clients at concerts, through trips or sports events. Previously you could deduct up to 50% of entertainment expenses but as of 2018 you will not be allowed a tax deduction for entertainment event business expenses. Changes can be made to these requirements yearly so you’ll want to make sure to check updated guidelines for newly adjusted tax limitations.
Rent & utilities
You can deduct the rent you’re paying if you are using the property for business purposes, but if you’re paying rent on a property you will eventually own (rent-to-own) the rent is not deductible. This deductible expense also includes rented office furniture and utility fees you pay to maintain your business.
We know that your marketing costs can add up. You can deduct any marketing expenses that promote your product or business’s offering (websites, billboards, mail, etc.) and you can also deduct sponsored advertisements for charity, such as creating advertising materials that sponsor a charity drive. In addition, any survey administration costs and public relations efforts are considered tax deductible business expenses.
Employee pay & benefits
Business owners can deduct employee pay, which includes base salary, bonuses, and any additional commissions paid.
- The compensation must be reasonable: Others in these roles are getting paid similarly.
- Sums must be paid out: You cannot claim deductions for payroll that has yet to be issued.
- Special attention must be paid to business owner compensation: Not all business owner pay can be classified as a deduction. You must follow IRS guidelines when deducting business owner pay.
These rules are designed so business owners cannot take advantage of compensation that is being paid unfairly to employees or owners. There are additional stipulations from the IRS so be sure to research carefully before deducting.
Employee benefits are a huge cost to employers and vital to employees. As a business owner you can deduct health insurance, retirement plans, variations of life insurance, dependent care, employee discounts, and more. Keep track of the various business expenses you incur for employee benefits so you can maximize your benefit deductions at the end of the year.
Random gift expenses are a minimal business deduction and cap out at $25 per person annually. You do not need to claim gifts given to clients if they are less than $4, widely given and display the company logo (think low-cost company SWAG like pens).
General office expenses
The following list details the most common tax write-offs as deductible business expenses, but there are still additional deductions you can make for your business. Office expenses can be significant for a small business owner, and you’re able to claim purchases that serve a specific business purpose. Some of these deductible business expenses include:
- Bank fees and interest
- Business insurance
- Office furniture & supplies for the workplace (soap, toilet paper, etc.)
- Memberships & subscriptions
- Legal fees
This is by no means an exhaustive list of deductible expenses, and we encourage all business leaders to work closely with their finance teams or accountant to maximize their business tax deductions.
How to maximize savings with business deductions
If you aren’t properly filing your business deductions, you’re leaving money on the table. Or, more accurately, you’re basically paying for things twice. Tax deductions are crediting you for purchases you’ve made for your business, so it’s crucial that you carefully document and file each of those purchases.
Accurately track your expenses
It’s difficult to maximize your business deductions when you don’t remember or have evidence of eligible business expenses. Find a system that works for your team which will track expenses and make it easy to categorize and find expenses throughout the year. Proper expense management will mean having access to every transaction so that business owners or accountants can properly deduct rent, marketing costs, and other tax write-offs.
Unlike personal taxes, you don’t use standard or itemized deductions when filing business taxes. Business tax deductions fall under three categories: actual, ordinary, and capital.
Categories of business expenses:
- Actual expense: Actual expenses are deductions that are the actual cost of an item you get a deduction for. Ex: receipts and mileage driven.
- Ordinary expense: Ordinary expenses (or normal expenses) are expenses you incur when running a business. Ex: rental expenses, utilities, and benefits.
- Capital expense: Capital expenses cannot be deducted and need to be capitalized because they are investments in nature. Ex: improvements, business assets and start-up costs.
Some business expenses are one-time purchases that are an investment to generate revenue, but will most likely depreciate over time. These types of purchases are typically equipment, real estate, or sometimes vehicles. One way to partially claim these purchases for deductible business expenses is to capitalize the expense.
Capitalizing an expense means claiming the depreciation of the purchase on the business’s income statement as a way to accurately reflect assets.
Spending smarter starts small with categorizing your expenses so that you’re aware of every purchase and eligible for the maximum deductions on your taxes. Divvy wants to help you get started now.