Small Business Tax Deductions

The tax structure of many small businesses allows the owner to deduct certain expenses.  This helps reduce their personal tax liabilities.  It is important to establish your small business to take advantage of tax rules that minimize your tax burden.  It’s also important to know what expenses can be deducted.

Sole proprietorships, partnerships, and Limited Liability Companies (LLC) are known as pass-through business structures.  Unlike a corporation, which pays taxes as an entity of its own, the income, losses and business expenses of a pass-through entity are attributed to the business owner or shareholders.  Pass-through income avoids the issue of double taxation that owners of a corporation deal with, so it is often a more tax efficient to work under.  S Corporations are also considered pass-through entities, however, there are limits to allowed tax deductions.

Sole proprietors and individually owner LLCs report their business taxes using  Schedule C “Profit of Loss From Business”.  Partnerships and multimember LLCs report their income using Form 1065 “U.S. Return of Partnership Income”.  A Schedule K-1 “Partner’s Share of Income, Deductions, Credits, etc.” informs each partner what their portion of the tax liability is. These forms include sections where the business owner can enter their costs of doing business.  It’s important to know what can be deducted so that the business owner can track these expenses throughout the year.

List of Deductible Business Expenses

Advertising

Sole Proprietorships and single member LLCs  – Schedule C Line 8

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 20

Advertising is a broad category of deductible expenses which includes:

  • Advertising in various media such as newspapers, TV and cable, online and magazines
  • Cost of listing your new business after filing with the Arizona Corporation Commission
  • Activities such as direct marketing
  • Email newsletters campaigns
  • Costs or producing advertising materials such as business cards, brochures, and websites
  • Costs of advertising events such as a publicity campaign or special promotion
  • Meals and entertainment for promotional activities (not subject to the 50% limit)
  • Temporary promotional signs
  • Cost of help wanted adverting

Most marketing is done online now.  Social medial and search engine websites will often track and report on how your marketing is performing as well as how much you have spent.  You can save on marketing services online by starting with free services offered by sites like MailChimp for email marketing or WordPress.com for websites and blogs.

Not all marketing activities can be deducted as advertising.  Permanent signs are not advertising, though they are considered a long term asset that can be depreciated.  The cost of advertising on your vehicle can be deducted, however, this does not allow you to deduct the cost of driving your vehicle as an advertising expense.  As with combining advertising with personal vehicle use, the cost of combining marketing with personal activities cannot be deducted.

Car and Truck Expenses

Sole Proprietorships and single member LLCs – Schedule C Line 9

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line20

The IRS allows sole-proprietors to deduct automobile expenses if you consider your home your primary place of business and you can prove that the expenses are business related.  Partners can deduct expenses of their personal vehicle if it is used for business purposes.  The following list:

  • The home of a client
  • The office store where you buy office supplies
  • A temporary job site where you work for clients
  • Places where you meet with clients, customers, or business advisers
  • A warehouse or the place where you keep your business inventory
  • A convention center where you participated in a business seminar.

Business owners have the option of calculating the actual cost of using their vehicle, or using the IRS standard mileage rate, which is $.54 per mile in 2017.   There is a limit of four vehicles under the standard mileage rate, and it cannot be used if the vehicle is subject to depletion.  Tracking apps can be used to track business miles, and those costs can also be deducted.

Commissions and Fees

Sole Proprietorships and single member LLCs  – Schedule C Line 10

Partnerships, multi-member LLCs and S Corporations  – Form 1065 Line 20

Small business owners can deduct fees paid to employees and contractors for their work. The following is a list of items that the owner

  • Transaction fees
  • Processing fees
  • Referral fees
  • Selling fees
  • Finder’s fees
  • Sales commissions
  • Fees for legal referrals
  • Shared commissions paid for real estate
  • Fees for online referrals

Contract Labor

Sole Proprietorships and single member LLCs – Schedule C Line 11

Partnerships, multi-member LLCs and S Corporations –  Form 1065 Line 20

This deduction is for the cost of labor for work from people business owners do not treat as employees.  This does not include the costs for accountants and attorneys, payments for repairs and maintenance, or payments to employees.

If the cost of contract labor exceeds $600 for the year, the business owner must report the income to both the IRS and the contract laborer on Form 1099-MISC.

Depletion

Sole Proprietorships and single member LLCs – Schedule C Line 12

Partnerships, multi-member LLCs and S Corporations –  Form 1065 Line 17

Depletion the use of natural resources in mining, drilling, producing timber or quarrying of stone.  This deduction allows the business owner to account for the reduction in natural resource reserves.

Depreciation and Section 179 Expenses

Sole Proprietorships and single member LLCs  –  Schedule C Line 13

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 16a

Depreciation is an annual allowance for wear, deterioration, or obsolesce of property (excluding land) such as buildings, machinery, vehicles, furniture, and equipment.  Most property is depreciated according to what is known as MACRS (Modified Accelerated Cost Recovery System).  Small business owners need to identify the following items in order to calculate MACRS:

  • The depreciation method for the property
  • The class life of the asset
  • Whether the property is “Listed Property”
  • Whether the taxpayer elects to expense any portion of the asset
  • Whether the taxpayer qualifies for any “bonus” first year depreciation
  • The depreciable basis of the property

Improvements to a property can be deducted by depreciated the cost.  Repairs, on the other hand, are deducted during the current year, and are listed under Repairs and Maintenance.  Certain qualifying property can be recovered in the year it is first put into service.  In order to deduct the property, the owner must elect to take a Section 179 Deduction.

Employee Benefit Programs

Sole Proprietorships and single member LLCs   –  Schedule C Line 14

Partnerships, multi-member LLCs and S Corporations –  Form 1065 Line 19

Small business owners can deduct the expenses of fringe benefit programs.

  • Accident and Health Care Plans
  • Group Term Life insurance
  • Dependent Care
  • Employer provided cell phone
  • Meals
  • Retirement planning services

Insurance (other than health)

Sole Proprietorships and single member LLCs –  Schedule C Line 15

Partnerships, multi-member LLCs and S Corporations –  Form 1065 Line 20

Health insurance for small business owners is reported as an adjustment to their gross income on Form 1040, line 29 “Self-employed health insurance deduction.”  The other forms of insurance required by a business owner can be deducted as a business expense.  The following are some of the expenses that can be deducted:

  • insurance that covers losses from business bad debts
  • Liability insurance and malpractice insurance
  • Workers’ compensation insurance set by state law
  • Contributions to a state unemployment insurance fund
  • Life insurance covering your officers and employees
  • Business interruption insurance that pays for lost profits if your business is shut down due to a fire or other cause

Auto insurance can be deducted as a business only if the business owner opts to use the actual cost of automotive expenses instead of the standard mileage rate offered by the IRS.

Mortgage Interest

Sole Proprietorships and single member LLCs   – Schedule C Line 16a

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 15

Business owners that own real estate used for business purposes can deduct the mortgage interest.  Unlike personal residence mortgage interest, the business owner has no limit on interest deductions.

Business owners who use their home to conduct business can deduct the expense for the business use of a primary residence.  In order to claim a deduction for the business, two basic requirements must be met.  First, the home must be used for the business on a regular and exclusive basis.  Second, the business owner needs to show that the home is the principle place of business.  If the tests are met, the home owner can either use a simplified option or regular method to determine the home deductions.

Interest

Sole Proprietorships and single member LLCs   – Schedule C Line 16b

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 15

The IRS allows you to deduct other interest as long as:

  • You are legally liable for that debt.
  • Both you and the lender intend that the debt be repaid.
  • You and the lender have a true debtor-creditor relationship.

Legal and Professional Services

Sole Proprietorships and single member LLCs   – Schedule C Line 17

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 20

The cost of financial advisors, accountants, attorneys or other professionals who are independent of your business, but needed in what is considered “ordinary and necessary” to your business, can be deducted.

  • Professional association membership fees
  • Organization dues (including state bar dues)
  • Legal fees for business matters
  • Accountant fees
  • Short-term consulting fees
  • Management consultation fees
  • Technical marketing consultation fees
  • Engineering consultation fees
  • Marketing consultation fees
  • Fees paid for Web site analysis
  • Other outside consulting fees for short-term advice on specific deals
  • One-time logo and web design fees
  • Fees paid to talent agents and business and personal managers who are not paid as employees

Office Expense

Sole Proprietorships and single member LLCs – Schedule C Line 18

Partnerships, multi-member LLCs and S Corporations  – Form 1065 Line 20

Office supplies and postage are entered here.

Pension and Profit-Sharing Plans

Sole Proprietorships and single member LLCs  – Schedule C Line 19

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 18

Contributions to small business retirement plans, including a Self Employed Pension (SEP IRA), a Savings Incentive Match Plan for Employees (SIMPLE IRA), and 401k, can be deducted by the business owner.  Depending on the size of the small business, the owner will either complete Form 5500-EZ “Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan or Form 5500-SF “Short Form Annual Return/Report of Small Employee Benefit Plan.”

Rent or Lease

Sole Proprietorships and single member LLCs – Schedule C Line 20

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 13

Sole proprietorships enter vehicles, machinery other equipment is listed on line 20a.  Amounts paid to rent or lease other property, such as office space, are listed on line 20b.

Repairs and Maintenance

Sole Proprietorships and single member LLCs – Schedule C Line 21

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 11

Repairs keep purchased property in good operating condition, and can therefore be claimed as a current year deduction.  Examples of repairs and maintenance include:

  • Painting
  • Repairing driveway
  • Replacing window glass
  • Repairing the roof
  • Repairing appliances

Supplies

Sole Proprietorships and single member LLCs – Schedule C Line 22

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 20

Supplies include the costs of materials consumed and used by the business.  Incidental materials and supplies may be deducted provided that:

  • No records are maintained indicating when supplies are actually used,
  • No inventory is taken of the amount of supplies on hand at the beginning and end of the year, and
  • This method does not distort income.

Supplies used directly or indirectly in the manufacture of goods are part of the cost of goods sold are listed in Schedule C Part III “Cost of Goods Sold” Line 38 Materials and Supplies.

Taxes and Licenses

Sole Proprietorships and single member LLCs – Schedule C Line 23

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 14

  • State income taxes
  • Employment taxes
  • One-half of self-employment taxes from line 27 of Form 1040
  • Personal property tax on property used by business
  • Sales tax
  • Real Estate tax
  • Excise taxes
  • Fuel Taxes
  • Licenses
  • Regulatory fees

Travel, Meals and Entertainment

Sole Proprietorships and single member LLCs – Schedule C Line 24

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 15

Small business owners may need to entertains clients or prospective customers.  The IRS allows a business owner to take deduction for 50% of qualifying business entertainment expenses. The expense must qualify as a meal or entertainment that is has a relationship to your business activities.  Adequate records must be kept to substantiate the expenses.  Some of the qualifying activities include:

  • Nightclubs
  • Social, athletic and sporting clubs
  • Theaters
  • Sporting events
  • Hunting, fishing, vacation or similar trips
  • Travelling expense

Utilities

Sole Proprietorships and single member LLCs – Schedule C Line 25

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 15

You can deduct the utilities needed to run a small business.  Some utilities, such as internet or cell phones, often are split between personal and business use.  While the IRS used to require a line by line break down of the usage, the generally accepted rule is to estimate the time usage.  An itemized bill will help, but it is generally advisable to underestimate your business use when taking a deduction.

The Small Business Jobs Act of 2010 changed many of the rules regarding cell phone depreciation.  Prior to the law, cell phones were depreciated under a ten-year schedule.  Currently, they can be depreciated on a seven year schedule, though the chances of a cell phone lasting that long is highly improbable.  If the business usage of the cell phone exceeds 50% of use, the phone can be deducted as a Section 179 expense under IRC Sec. 280F(b)(2).

Wages

Sole Proprietorships and single member LLCs – Schedule C Line 26

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 9

Salaries, wages, commissions and bonuses paid to employees are deductible if they are deemed to be ordinary and necessary, reasonable in amount, and paid in the year services were performed.  Others forms of compensation that may be deducted include:

  • Sick leave
  • Vacation pay
  • Education expenses
  • Reimbursements
  • Loans to employees with no expectation of payback

Other expenses

Sole Proprietorships and single member LLCs – Schedule C Line 27a

Partnerships, multi-member LLCs and S Corporations – Form 1065 Line 20

S Corporation Deductions

S Corporations have limitations on how much the shareholder can deduct from their income.  Losses are limited to the shareholder’s basis in the company.  Tracking your business’s basis for S Corporation business deductions is the owners responsibility.

 

Disclaimer:  The information provided is not intended to be legal or tax advice.  Every business situation is different, and IRS tax rules change annually.  Consult with you tax and legal advisors before making any business decisions. Phoenician Financial Planning, LLC offers tax planning consultation services.

 

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