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A small business offers plenty of opportunities for tax deductions. Just be sure to follow IRS rules.
Here are 12 that even savvy small-business owners and entrepreneurs sometimes forget.
1. Home office
To claim your home office on your taxes, the IRS says it must be a space devoted to your business and absolutely nothing else.
The deduction isn’t limited to a full room. Your home office can be part of a room. Measure your work area and divide by the square footage of your home.
That percentage is the fraction of your home-related business expenses — rent, mortgage, insurance, electricity, etc. — that you can claim.
There’s also a simpler way to claim a home office deduction. Consider both the regular and simplified methods of writing off your home office.
“I don’t agree that chances of getting audited are greater with a home office deduction,” says Zobel, a San Francisco Bay-area tax expert who specializes in serving the self-employed. The key is that you use the term “home office” the same way the IRS does. The tax agency says it must be a space devoted to your business and absolutely nothing else. Deducting the den that houses the family computer and serves as a guest bedroom won’t fly with Uncle Sam.
“If you only have one computer and you have a child over 4, the IRS is going to be pretty certain that the child is using the computer,” says Zobel. “And the burden of proof is on you.”
The deduction, however, isn’t limited to a full room. Your home office can be part of a room. Just how much of the space is deductible? Measure your work area and divide by the square footage of your home. That percentage is the fraction of your home-related business expenses — rent, mortgage, insurance, electricity, etc. — that you can claim.
There’s also a newer way to claim a home office deduction. Read “Use newer, simplified home office deduction” for details.
2. Office supplies
Even if you don’t take the home office deduction, you can deduct the business supplies you buy. Hang on to those receipts, because these expenditures will offset your taxable business income.
Office-furniture acquisitions provide two choices:
- Deduct 100 percent of the cost in the year of the purchase.
- Deduct a portion of the expense over seven years, also known as depreciation.
To take the whole cost in one tax year, use the Section 179 deduction. There deduction cap for 2016 taxes is $500,000, but may be adjusted for inflation in future years.
If you choose instead to depreciate the desks and filing cabinets, you can’t simply split the cost into equal portions over the depreciation period. Instead, you must use an IRS chart to make separate calculations each year.
Which is better for you? Anticipate the times that your business will need these deductions the most. Both options are reported on IRS Form 4562.
4. Other equipment
Items such as computers, copiers, fax machines and scanners are tax-deductible. As with furniture, you can take 100 percent upfront or depreciate (this time over five years).
Does your business need a new copier? Put it on a business credit card.
5. Software and subscriptions
Section 179 provides another tax break. New computer software a business buys can be fully expensed in the year purchased.
For business and industry-related magazine subscriptions you can deduct the total costs as a full deduction in the year spent.
If you drive for business, the IRS wants to give you some of your money back. You’ll need documentation, so keep a notebook in your vehicle to record the date, mileage, tolls, parking costs and the purpose of your trip.
At the end of the year, you have two choices:
- Total the mileage and add in the tolls and parking to calculate your deduction. Once you have your mileage total, multiply it by 54 cents for your 2016 deduction. For 2017 business tax purposes, the rate drops to 53.5 cents a mile.
- Measure your business usage against your personal driving and deduct that portion of your auto-related expenses. Remember to include gas, repairs and insurance.
If you are leasing, include those payments.
If you are buying the car, factor in the interest on your loan and depreciation on your vehicle.
If your company’s office is at your house, you can deduct the entire business-related mileage, from the minute you pull out of the driveway until you return home.
If your business is not home-based, your mileage meter starts at your first business-related destination and ends at your last. You can’t include the drive to and from home. In this case, try to schedule several business appointments on the same day to allow you to take the mileage between stops as a tax write-off.
7. Travel, meals, entertainment and gifts
Good news, small-business travelers. You might as well stay in a nice hotel, because the entire cost is tax-deductible. Likewise, the cost of travel — air, rail or auto — is 100 percent deductible, as are costs associated with life on the road (dry cleaning, rental cars and tipping the bellboy).
The only exception is dining out. You can deduct only 50 percent of your meals while traveling. So stay at the Ritz and eat at Wendy’s.
Once you get home, your on-the-job meals aren’t deductible — unless you bring along a client to talk business. In this case, you might consider splurging on a fancier meal because then you can write off half such work-related dining costs.
The 50 percent deduction limit applies to most other client entertainment expenses, too. But a direct gift to a client or employee is 100 percent deductible, up to $25 per person per year.
8. Insurance premiums
Self-employed and paying your own health insurance premiums? These costs are 100 percent deductible.
This break primarily benefits proprietorships, but there are limits. The deduction can’t be more than your business’ net profit. And it’s not allowed if you were eligible for other health care coverage, including that offered by your employed spouse’s medical plan.
Did your spouse work for you last year? You can get the full medical premiums deduction on your return. As an employee, your spouse’s premiums are 100 percent deductible; if you and the children were on his or her policy as dependents, so are those costs.
- Your spouse’s employment must be real, not in name only, and you must offer coverage equally to any other employees.
- Failure to meet these requirements could result in a lawsuit, an audit or both.
You also can include some of the premiums you pay for long-term care insurance for yourself, your spouse or dependents.
9. Retirement contributions
Are you self-employed and saving for your own retirement with a SEP IRA or Keogh? Don’t forget to deduct your contribution on your personal income tax return.
10. Social Security
The bad news: If you’re self-employed or starting a small business, you have to pay double the Social Security contributions you would as an employee. That’s because federal law requires the employer pay half and the employee pay half. Self-employed workers are both, meaning the total will equal 15.3 percent of your net profits.
The good news: You can deduct half of the contribution on your 1040.
11. Telephone charges
You can deduct the cost of the business calls you make for business from home. When your bill comes in, circle the business-related calls, total them up and keep a copy. At the end of the year, tally your 12 bills and deduct 100 percent.
Regular fees and charges on your phone line don’t count toward your deduction. But if you have a second line installed and use it only for business, all of these charges are deductible.
If you use your cellphone for your business, you can claim those calls as a tax deduction. If 30 percent of your time on the phone is spent on business, you could deduct 30 percent of your phone bill.
12. Child labor
If you hire your children as employees at your business, you may be able to deduct their salaries from your business income if they meet certain requirements.
Also, there is no Social Security tax when you hire your child who is 17 or younger and you can deduct the salary as a business expense.
This break is available, however, only if you operate as a sole proprietor or as a partnership in which you and your spouse are the only partners. If your business runs as a corporation, then it, not you, is considered the employer and the corporation is not relieved of the tax liabilities.
Paul S. Herman CPA, a tax expert for individuals and businesses, is the founder of Herman & Company, CPA’s PC in White Plains, New York. He provides guidance and strategies to improve clients’ financial well-being.