Deductions for small businesses can be categorized into three buckets: items you assume are deductible, items you did not know were deductible, and items you can deduct strategically.
Deductible Items
These are expenses that most small business owners “know” are deductible. The IRS says that ANYTHING that is ordinary and necessary to operate your business is deductible. That is a broad statement! However, the devil is in the details. The IRS rarely audits tax returns these days, but when they do, you had better be able to back up your expenses. You need documentation of the expense, but you also may need to answer why the expense is ordinary and necessary.
Things You May Have Not Thought About
Some commonly missed expenses for small business owners:
1. Expenses Spent Personally. This is not so much that you did not know you could deduct them, but a matter of poor record keeping. For instance, you may have a vehicle that you use primarily for business, and you properly deduct those expenses. But, what about the occasional times you use other personal vehicles? Or when you charge a business expense to your personal credit card? The best practice is to submit an expense report to your business, just as any other employee would. Read more about the subject in this article.
2. Qualified Business Income Deduction. This is a recent deduction created with theTax Cuts and Jobs Act. You can read about it here.
3. Tax Credits. Unlike a business deduction, a credit actually reduces your tax dollar for dollar. Although many of the federal credits available are specific to an industry (e.g. oil and gas), there are many that can be used by small businesses of all stripes. For instance, there is a credit for starting a retirement plan and one for investing in technology and process improvement. Do not assume there is nothing there for you!
Strategy
This is the most powerful category of expenses because usually it takes money you were already spending and putting a strategy behind it to maximize your taxes. For instance, hiring your child in your business. Most people give their children an allowance. How about turning it into a business deduction? In this case, its money you are already spending, you are just doing it in the most effective way.
One of the most underutilized strategies is using qualified retirement plans to reduce taxes. By simply moving money from one bucket to another, you’ve increased your after tax income. You can read more about the retirement plan strategy in this article.
