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Tax season guide to small business expense deductions

From the kind of expenses you can – and can't – deduct to the right rewards card to use to pay for deductible expenses, here's everything you should know

Summary

Claiming deductions can save your business money on your tax return, but you might be wondering what expenses you can deduct. We’re here to help. Here’s everything you should know about deductible expenses for small businesses.

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Whether you love tax season or hate it, you can’t put off preparing and filing your return. One thing that can make the task more pleasant is maxing out all the various tax deductions your business qualifies for.

Claiming deductions can save your business money at tax time if it reduces your taxable income (and hopefully, your tax bill). But just what can you deduct?

This guide covers everything you need to know about writing off business expenses.

See related: 1099-C surprise: Canceled debt often taxable as income

Defining deductible expenses

“Generally, all deductible expenses must be ‘ordinary and necessary’ to the business per the IRS,” says Kaylee Wold, a certified public accountant at ALL CPAs in Chestnut Hill, Massachusetts.

  • Ordinary expenses are common to your industry or business.
  • Necessary expenses are ones that are helpful to or appropriate for your business.

The IRS doesn’t require an expense to be “indispensable” to meet the necessary standard. Uncle Sam also distinguishes deductible business expenses from these expenses:

  • Expenses used to figure the cost of goods sold – such as raw materials, labor costs, and factory overhead.
  • Capital expenses – including startup costs, business assets and improvements to the business.
  • Personal expenses – meaning living or family expenses.

While you might be able to write any of these off elsewhere on your return, they wouldn’t technically qualify as deductible business expenses.

What’s deductible for businesses this year?

The Tax Cuts and Jobs Act made some changes to business deductions. This table highlights the most significant expenses you can deduct for the 2018 tax year:

Tax season 2018: Main deductible expenses

Deductible expenseQualifying rulesHow much is deductible?
Business use of your home
  • Must regularly use part of your home for business.
  • Your home must be the principal place of business.
  • Simplified method: $5 per square foot (up to a max of 300 square feet).
  • Regular method: Percentage of the home used for business.
Business use of a vehicle
  • Business owners can claim a standard mileage deduction, OR actual expenses, but not both.
  • Standard mileage deduction applies to business miles only, not commuting miles.
  • Standard mileage: 54.5 cents per mile.
  • Actual expenses: Determined by the percentage of use, based on miles that the vehicle is used for business.
Depreciation (Section 179 Deduction)Applies to:

  • Assets used in the business or held to produce income.
  • Assets expected to last more than one year.
  • Assets that lose value over time.
  • Up to $ 1 million, adjusted for inflation in subsequent tax years.
Employee compensationApplies to:

  • Compensation paid to employees.
  • Fringe benefits, such as health insurance, sick pay, vacation pay.
  • Additional employee benefits, such as group-term life insurance premiums, adoption assistance, employee use of a vehicle and reimbursed employee travel expenses.
  • Amounts that meet the “reasonableness” standard – in other words, the amount of compensation paid to employees must be fair and appropriate for their position and duties.
Bad business debtsDebts must meet these three requirements:

  • Someone (i.e., a vendor, client, etc.) is legally obligated to repay it to you.
  • They must be uncollectible – you must be able to prove you attempted to collect.
  • You must have sustained a loss because of the debt.
  • Amounts meeting the standard for a bad business debt.
Business travel and mealsTravel and meals are deductible when:

  • Business duties require you to be away from home longer than a typical workday.
  • You need to sleep or rest to keep up with the demands of your work while you’re away.
  • Travel expenses: 100 percent of the cost of qualified business travel expenses.
  • Meals: 50 percent of the cost of business meals.
Business interest
  • Applies to interest paid for business debts, such as loans, lines of credit, equipment financing, inventory financing, and credit cards.
  • 30 percent of taxable business income.
InsuranceApplies to insurance premiums paid for:

  • Coverage for losses from unpaid debts.
  • Casualty and theft insurance.
  • Professional liability or malpractice insurance.
  • Accident and health insurance.
  • Vehicle insurance for business use.
  • Overhead insurance.
  • 100 percent of qualified insurance premiums.
TaxesApplies to:

  • Worker employee taxes.
  • Real estate taxes.
  • State and local income tax.
  • State and local property tax.
  • 100 percent of the qualified tax amount paid.
Advertising expensesIncludes:

  • Online advertising, such as pay-per-click marketing, social media ads, and SEO services.
  • Costs associated with webpage design and online promotional events.
  • Print advertising expenses.
  • Direct marketing expenses.
  • 100 percent of the qualified advertising expenses.
Charitable donationsApplies to:

  • Cash contributions.
  • Gifts of property.
  • Mileage and travel expenses associated with volunteering for a qualified charity.
  • 60 percent of adjusted gross income.

Other deductible expenses

Other deductible expenses include education expenses, rent, professional dues or subscription fees, office supplies, stamps and postage, professional licenses or regulatory fees and outplacement services for employees who are laid off.

There’s also a deduction for contributions to small business retirement plans, including:

  • Simplified Employee Pension Plans (SEP IRA).
  • Savings Incentive Match Plan for Employees (SIMPLE IRA).
  • Individual 401(k) plans – these are reserved for sole proprietors or business owners whose only employee is their spouse.
  • Traditional 401(k) plans.

Tax deductions and retirement contributions

One thing to watch out for is how claiming other business deductions affects the amount you can save in a qualified retirement account. Small business retirement plans limit your contributions to a certain amount, based on your income.

“When you have a lower income you typically have lower taxes, but one of the benefits of having a higher income is that you can contribute more to a pension or retirement plan,” says Paul T. Joseph, a certified public accountant and founder of Joseph & Joseph Tax & Payroll in Williamston, Michigan. “Once you lower that income, you also lower the amount you can invest in a retirement plan.”

In other words, claiming more business expense deductions could mean paying less in taxes but it could shrink your retirement contributions. That’s potentially the biggest downside with deducting expenses.

There may be another drawback if you plan to apply for a business loan or a personal loan, such as a mortgage. On paper, deductions can significantly reduce your business income, which might make you appear riskier to lenders.

Business expenses you can’t deduct

While there’s a lot you can deduct for your business, certain expenses are off-limits.

“Entertainment expenses are not deductible anymore,” says Wold, “even if the entertainment involves a relationship between a business and a client.”

If you previously wrote off club dues, sporting event tickets or concert tickets related to client outings, for example, that’s one tax break you won’t be able to claim moving forward.

“Additionally, there’s no longer a deduction for employer-provided transportation fringe benefits provided to employees,” says Wold, such as parking or public transit passes.

To round out the list, you can’t deduct these expenses either:

  • Federal income tax payments.
  • Political campaign contributions or lobbying expenses.
  • Fines or punitive damages associated with a civil or criminal case.

Claiming the 20 percent pass-through deduction

One important addition to the tax code is the 199A or qualified business income deduction for pass-through entities.

“Generally, the deduction is 20 percent of qualified business income before limitations,” says Wold. Qualified business income just means net business income after business deductions or losses are taken out. This deduction is available to pass-through entities, including s-corporations and partnerships, but there are two big limitations, says Wold.

“If a business performs services within certain IRS-specified industries, they generally can’t take the deduction,” she says.

If you run a service business in the health, law, accounting, actuarial, performing arts, consulting, athletics, financial services or brokerage services industries, you wouldn’t make the cut for this deduction. Businesses that do qualify may be limited on what they can deduct.

“The deduction can’t exceed the greater of either 50 percent of the company’s wages or 25 percent of those wages, plus 2.5 percent of the basis in the company’s tangible, depreciable property,” says Wold.

There’s an exception for single filers with taxable business income of $157,500 or less, and married couples with taxable income under $315,000. Those business owners would be able to take the full 20 percent deduction.

Using a rewards credit card to pay for deductible business spending

A business credit card can offer convenience in paying for business expenses, as well as miles, points or cash back on purchases.

“Paying for business expenses, including the purchase of equipment, inventory, charitable donations, etc. have the same treatment as if the business paid with cash or checks,” says Wold. “You can use a credit card to pay deductible expenses in 2018 to claim the deduction. Even if you don’t pay off that credit balance until 2019, it will still be deductible on the 2018 return.”

If you’re planning business spending for this year, consider these cards for covering deductible expenses:

Best credit cards for deductible expenses

Rewards Card Good for:
SimplyCash® Plus Business Credit Card from American ExpressEarning cash back on office supplies, wireless phone services, business travel and meals, shipping, advertising, computer hardware and software, cloud services.
Chase Ink Business PreferredEarning cash back on travel, shipping, online advertising, internet, cable and phone services.
Capital One Spark MilesEarning miles on every purchase; transferring miles to selected travel partners.
American Express® Business Gold CardEarning points on airfare purchased directly from airlines, gas, restaurants, shipping, online advertising purchased through select media, computer hardware and software, cloud services.

 

Any interest expense you pay on the card wouldn’t be deductible until it’s added to the balance, says Wold. Just know how much interest you can deduct.

“The Tax Cuts and Jobs Act did impose some new limits on deducting business interest, primarily related to a new cap on deducting interest of 30 percent of adjusted gross income,” says Mark Luscombe, federal tax analyst at Wolters Kluwer Tax & Accounting. He notes that there’s an exemption from that limit for businesses with average annual gross receipts of $25 million or less.

One rule remains the same: “If it’s a personal purchase, there’s no deduction for the interest charge,” says Luscombe.

That’s important to take heed of if you use your business rewards card for both business and personal spending.

Pay close attention to record keeping

When paying for deductible business expenses, make sure you leave a paper trail.

“Documentation is the key to being able to deduct any expenses in the eyes of the IRS,” says Joseph. “Accordingly, business owners should painstakingly document the deductions they plan on taking on their returns.”

Using a credit card for business spending simplifies the process.

“By using a credit card to pay for these purchases, you have an immediate source of documentation that typically itemizes what each purchase is,” says Joseph. “There are certain credit cards that will combine and compile all the expenses by category on an annual basis and provide that report to you, which you can use to document your expenses.”

That can make deducting business expenses less stressful once tax season gets underway.

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