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Business vs. Capital Expense
Before discussing specific small business tax deductions, you must first understand the two classifications of expenses. There are business expenses, and then there are capital expenses. Both fit the criteria of "ordinary and necessary", however, both do not qualify as tax deductions in a small business.
Business expenses are the typical day-to-day costs of doing business. These include items such as rent, utilities, insurance, travel, and employee salaries - these expenses are deductible.
Capital expenses involve acquiring assets for the business such as vehicles, real estate, or equipment. These items have an expected useful life for the business. While they may be necessary, the cost of acquisition is not deductible. However, you can claim depreciation or depletion of the asset as a deduction.
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Business Expenses as Tax Deductions
To meet the IRS criteria of “ordinary", the expense must be common to either businesses in general, or common to similar businesses in the same industry. To qualify as “necessary", you must be able to show that the expense helped directly improve business operations, or increased revenues (directly or indirectly). Some examples of appropriate tax deductions in a small business include:
- Advertising expenses
- Commissions, contractor fees, employee wages or salaries
- Expenses relative to employee benefit programs
- Professional or legal services
- Certain types of interest
- Office and other general supplies
- Rents and utilities
- Routine maintenance and repairs to assets (not improvements)
- Certain types of taxes, permits, licenses, and professional dues
- Bad debts (accounts receivable)
- Travel, meals, and entertainment
- Vehicle expenses
- Insurance premiums
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No Double Dipping
Certain expenses can be classified as a deduction in different ways. You can only claim an expense once. For example, if you use expenses such as raw materials and freight costs to compute cost of goods sold, you cannot then claim these expenses again as supplies or other deductible expense. Likewise, for vehicle expenses and other deductions, if you opt to use standard deductions, you cannot then claim individual expenses again elsewhere. Standard mileage deductions for example, include gas, oil, repairs, insurance, and other expenses incurred to use a vehicle in business operations. If you claim standard mileage, you cannot then claim car repair bills as a repair and maintenance deduction.
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Home-based vs. Brick & Mortar Businesses
For businesses operated out of the owner’s home, there are additional small business tax deductions to consider. Can I deduct a computer when starting up a home business? In some instances, if certain criteria are met, a portion of expenses such as purchasing a computer, or using a personal vehicle in the course of business may qualify as a deduction. Business use of the home, for example, allows filers to allocate a portion of home expenses like mortgage interest and utilities, to tax deductions of a small business.
Before jumping to declare personal expenses as business tax deductions however, owners should tread carefully. Exclusive use requirements apply to many deductions. In other cases, you may only be able to deduct a pro-rated or partial amount, based on mixed use between business and personal.
If you need help addressing specific tax questions, filing small business taxes, or learning more about what you can claim as a deduction, there are many options for free help with your business taxes, you can consult for assistance. If you have questions or doubts about a specific deduction, consult a tax professional, either free or paid, before claiming it on your taxes.
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References and Resources
Image courtesy of Darren Shaw - http://www.sxc.hu/photo/90360