Small businesses need to get their records and documents before the tax deadline this year to make sure they aren’t paying more taxes than they should. You can save money and make it easier to use deductions in the future by knowing which business expenses are deductible.
For the tax year 2021, here is a quick look at the business expenses that are deductible, what is not deductible, and some advice on how to keep better track of your business expenses.
How can business expenses be deducted from taxes?
The Internal Revenue Service (IRS) makes it relatively simple to determine which business expenses are and are not deductible. The key is keeping accurate records to organize everything in the right way.
Business expenses must be “necessary” and “ordinary.” A necessary expense is one that is “helpful and appropriate for your trade or business,” according to the IRS, while an ordinary business expense is one that is “common and accepted in your trade or business.” The tax agency also says that the cost does not have to be essential for it to be considered necessary.
Advertising, promotion, and marketing costs Bank charges, dues, and subscriptions Fixed costs (rent, insurance, property taxes, employee commissions, and salaries) Internet costs (web hosting, web design, domain names, WiFi) Employee education Licenses and permits Maintenance and repairs Office costs, utilities, postage, and supplies Office security Cybersecurity Communications systems Business travel expenses for the owner or employees Is a business line of credit tax deductible?
The fact that this capital is not considered taxable income is one of the advantages of taking on debt for your business. If you have a $100,000 line of credit, for instance, neither the entire amount nor the balance you use are considered business income. The same is true for loans to businesses.
You can claim the interest you paid on the line of credit, but you can’t deduct the repayment installments as a business expense. However, if you have a track record of using those funds for business purchases, the interest you have paid is not deductible.
Let’s say your business line of credit has monthly interest payments of 10%. You cannot claim the $500 in interest you paid on the $5,000 personal car repair purchase you made with the line of credit if you carry the balance for one month. Keep your personal and business expenses separate because of this. You can deduct $500 if the car in question qualifies as an ordinary or necessary expense related to running your business and can be listed as a business expense.
Also, if you use the line of credit to buy equipment (a capital expense), depreciation expenses can be deducted from your investment in the business. Typically, repairs are regarded as deductible business expenses.
You can keep track of which expenses are considered capital expenses and which are regular business expenses by keeping track of what you pay for with your business line of credit. Capital expenditures are not deductible on taxes.
Many of the costs associated with starting a business are considered capital expenses. In the following section, we will discuss capital expenditures in greater depth.
Non-deductible business expenses Keep in mind that not all business-related expenses are fully tax-deductible. Personal expenses, capital expenses, and expenses used to cover the cost of goods sold are examples of nondeductible expenses.
Cost of Goods Sold (COGS): If you produce goods or buy goods for resale, one part of running your business will be paying for those goods’ production or purchase. Cost of goods sold (COGS) includes things like the cost of raw materials, storage, shipping, labor, and factory overhead costs. If you run a service-based business, COGS do not apply.
The IRS considers you to be a small business taxpayer if your average annual gross receipts (total revenue) for the three previous tax years were less than $26 million. In addition, your COGS are deductible from your gross receipts. This is true for sole proprietorships and one-member LLCs that use Schedule C. When you are preparing your taxes, you need to make sure that the costs associated with your COGS are not included with any other business-related costs. Your tax forms have two distinct sections like these. It is not possible to include COGS-related costs once more as a deductible business expense.
The costs associated with this procedure are not considered deductible business expenses, regardless of whether your company purchases products for resale or manufactures them itself.
Instead, the costs of the materials, labor, transportation, and storage are taken out of the income of the business and accounted for separately from deductible expenses.
In the income section of your Schedule C (Form 1040), COGS is accounted for for sole proprietors and owners of single-member LLCs. Form 1065 is used by partnerships and multiple-member LLCs for tax purposes. COGS is included in your corporate tax returns, Form 1120 or Form 1120-S, under the income section for S corporations.
Capital expenses A capital expense is a cost incurred by your company for the company’s benefit in the future rather than an operating cost required for day-to-day operations. Fixed assets like equipment, vehicles, property, and franchise rights are examples of capital expenses. Capital expenses also include improvements to assets (such as renovating an office space). The expenses related with beginning your business are viewed as capital costs too. Both the direct and indirect costs of these expenses can be capitalized.
COGS are also considered a capital expense if your business does not meet the IRS’s definition of a small business. The direct costs and a portion of the indirect costs of COGS must be capitalized. Rent, interest, taxes, storage, and administrative costs are examples of indirect costs.
Capital expenditures cannot be deducted, but you can deduct depreciation, amortization, or depletion to recover some of the costs.
Keep your personal and business finances separate because the money you spend on your family and home life cannot be deducted as business expenses.
You can only deduct a portion of the costs that are shared by your personal use and business activities, even if you work from home. For instance, while the cost of the internet at home is likely a shared business and personal expense, office internet costs are regarded as an ordinary and necessary business expense.
In this case, in order to deduct the cost as a business expense, you will need to determine the proportion of time spent using the internet for business purposes versus personal use.
The Internal Revenue Service (IRS) offers tax advice to Gig Economy entrepreneurs who take on side jobs such as driving a food delivery vehicle, selling goods online, or providing contract-based creative services in order to supplement their income.
Some business expenses that were once deductible are no longer. Employee transportation benefits that you might have provided to help pay for parking, transit passes, or the cost of commuting are no longer eligible for tax deductions. Additionally, you are unable to deduct expenses related to business entertainment that do not include food and beverages. You can deduct half of the cost of the meal if the entertainment includes food and drinks. The IRS considers the entire cost of entertainment, and none of it is deductible, if the receipt does not separate the charges for the meal and entertainment.
How to keep track of business expenses more effectively Keeping track of business expenses is essential to any business’s success. By keeping track of your company’s expenses and reviewing them on a regular basis, you can avoid overspending, save money, and be better prepared for tax time. Try these suggestions to control your business expenses:
Learn how to use technology. Managing your company’s expenses can be easier to manage if you invest in accounting software and use it to its full potential.
There are a lot of software products with features designed specifically for small business owners. The best accounting programs are cloud-based, allowing you to update expense information from any location, feature helpful apps and integrations that enable automation, are highly customizable to your needs, and offer excellent customer support.
Right away, make detailed records. Get into the habit of keeping consistent, detailed records of your expenses whenever they occur to avoid the hassle of trying to locate expenses you incurred months ago. Ideally, you should store all of this data in your accounting software. Notes such as “Freelance service, web design” or “Utilities, cell phone” should be used to categorize each expense.
Keep personal and business expenses separate. Keep separate bank accounts and keep your records separated with care to avoid having business and personal expenses mixed up. Don’t use credit cards, personal loans, or lines of credit to pay for business expenses. Separating your personal and business expenses in advance will save you time and stress when filing your taxes.
Keep all receipts. Set aside a place to keep a copy of all your receipts, regardless of whether they are digital or printed on paper. Make this a routine that goes along with recording every expense in full and accurately. Your company may be audited at any time.
Use credit cards for business.
Using business credit cards can not only improve your company’s credit score but also makes it easier to keep track of spending because business credit card companies usually provide a year-end summary and break spending down by category on your statements. Additionally, you can download your statements directly into your accounting software.
Create a strategy for reimbursing employees. Businesses are required to reimburse their employees for work-related expenses like tools, supplies, and travel in some states, like California and Illinois. An accountable plan must be developed by your company in order to legally reimburse employees. As long as your accountable plan complies with IRS regulations regarding what constitutes reimbursement and what constitutes taxable wages or income for your employees, you are eligible to deduct reimbursements as expenses. You can make it easier to keep track of all of your employee reimbursements and the paperwork that goes along with them, like receipts for meals, hotel stays, and plane tickets, with an accountable plan.
As part of the American Rescue Plan, a new tax credit could be claimed by small businesses in 2021 to reimburse them for any time off they gave their employees to recover from COVID-19, receive or recover from COVID-19 vaccinations, or manage COVID-19-related family issues. This program ran from September 30, 2021 until then. You can claim this credit when you file your 2021 return if you haven’t already on your quarterly federal tax return. The IRS website contains additional information regarding this credit.
When you own a small business, filing your taxes can be overwhelming. You can manage the process with confidence if you regularly keep track of your expenses and research the IRS regulations that apply to your business well in advance.