Deductions Your Small Business Shouldn't Miss
Keep an eye out for these often-overlooked ways to cut your tax bill.
From the Nolo Small Business Center
It's very simple: the more tax deductions your business can legitimately take, the lower its taxable profit will be. And in addition to putting more money into your pocket at the end of the year, the tax code provisions that govern deductions may also yield a personal benefit: a nice car to drive at a small cost, or a combination business trip and vacation. It all depends on paying careful attention to IRS rules on just what is, and isn't, deductible.
When you're toting up your business's expenses at the end of the year, don't overlook these 14 common business deductions.
1. Auto Expenses
Operating a car is expensive. The good news is that if you use your car for business, or your business owns its own vehicle, you can deduct some of the costs of keeping it on the road. Mastering the rules of car expense deductions can be tricky, but well worth your while.
There are two methods of claiming expenses: You can either keep track of and deduct all your actual business-related expenses, or simply deduct a certain amount (36.5 cents in 2002 and 36 cents in 2003) for each business mile driven. As a rule, if you use a newer car primarily for business, the actual expense method provides a larger deduction at tax time.
If you use the actual expense method, you can also deduct depreciation on the vehicle. For the tax year 2002, the tax code allows a maximum depreciation deduction of $3,060 for the first year a vehicle is used in a business.
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If your auto is used for both business and pleasure, only the business portion produces a tax deduction. That means you must keep track of just how the vehicle is used, and add it all up at the end of the year. Certainly, if you own just one car or truck, no IRS auditor will let you get away with claiming that 100% of its use is business related.
2. Expenses of Going Into Business
Once you're running a business, expenses such as advertising, utilities, office supplies and repairs can be deducted as business expenses. But not so before you open your doors for business. The costs of getting a business started are capital expenses, which must be deducted over the first five years you are in business.
Tip: If you expect your business to make a profit immediately, you may be able to work around this rule by delaying paying some bills until after you're in business, or by doing a small amount of business just to get officially started. But if, like many businesses, you will suffer losses during the first few years of operation, you might be better off taking the deduction over five years, so you'll have some profits to offset.
3. Education Expenses
You can deduct education expenses if they are related to your current business, trade or occupation, but you must follow strict rules. The expense must be to maintain or improve skills required in your present employment, or be required by your employer or as a legal requirement of your job. The cost of education that qualifies you for a new job isn't deductible.
4. Legal and Professional Fees
Fees you pay lawyers, tax professionals or consultants generally can be deducted in the year incurred. But if the work clearly relates to future years, they must be deducted over the life of the benefit.
5. Bad Debts
If someone stiffs your business, the bad debt may or may not be deductible -- it depends on the kind of product your business sells.
If your business sells goods, you can deduct the cost of goods that you sell but aren't paid for.
If, however, your business provides services, no deduction is allowed for time you devoted to a client or customer who doesn't pay. The rationale behind this rule is that it would be too easy for businesses to inflate bills and claim large deductions for bad debts.
6. Business Entertaining
If you pick up the tab for entertaining present or prospective customers, you may deduct 50% of the cost if it is either:
- "directly related" to the business, and business is discussed
-- for example, a catered meeting at your office; or - "associated with" the business, and the entertainment takes place immediately before or after a business discussion.
Tip: On the receipt or bill, always make a note of the specific business purpose -- for example, "Lunch with Joyce Slater of Ace Manufacturing Co. to discuss widget contract."
7. Travel
When you travel for business, you can deduct many expenses, including the cost of plane fare, costs of operating your car, taxis, lodging, meals, shipping business materials, clothes cleaning, telephone calls, faxes and tips.
What about combining business and pleasure? It's okay, as long as business is the primary purpose of the trip. But if you take your family along, you can deduct only your own expenses, just as if you had traveled alone.
8. New Equipment
Some small businesses (those that spend less than $219,000 per year on depreciable items) can write off the full cost of some assets in the year they buy them, rather than "capitalizing" them -- deducting their cost over a number of years (see Current vs. Capitalized Expenses for information on expenses that need to be capitalized). Section 179 of the Internal Revenue Code allows you to deduct up to $24,000 of newly purchased equipment in 2002 and $25,000 in 2003. Some assets don't qualify for this § 179 deduction, including real estate, inventory bought for resale and property bought from a close relative.
