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Failing to claim all the small-business tax deductions you’re entitled to is like flushing money down the toilet. Deductions are a legal way to reduce the amount of business income that is subject to tax.
Keeping good records is key to backing up the deductions, says Barbara Weltman, author of “J.K. Lasser’s Small Business Taxes 2017.”
“Keep receipts, invoices and other documentation,” she says. “If you don’t have the proof, you could be out of luck.”
You probably know that you can deduct salaries and wages, mortgage interest and taxes, office supplies, the cost of repairs and insurance, and depreciation on property. But here are some commonly overlooked small-business tax deductions.
1. Home office deduction
Do you use a room in your home as your primary place of business, where you deal with patients, clients or customers? You may be able to claim a home office deduction on your personal income taxes, as long as you use part of your home exclusively for conducting business. But using a room as both an office and a place for guests to stay, for example, probably disqualifies you.
If you qualify, decide whether to deduct actual expenses or use the IRS’ simplified method.
If you deduct actual expenses, only amounts spent solely for the business part of your home will be eligible for full deductions (for example, painting or repairs in the area used for business). Indirect expenses — such as insurance, utilities, rent and general repairs — are deductible based on the percentage of your home used for business. Other unrelated expenses, such as lawn maintenance, are not deductible.
If you choose the simplified method, calculate your deduction by multiplying $5 by the square footage of the area of your home used for business. The IRS limits the area deducted under this method to 300 square feet, so the maximum simplified deduction is $1,500.
More information on qualifying for the home office deduction can be found at IRS Publication 587.
Capital losses, home office deductions and net operating losses are all overlooked deductions that can be carried over into future tax years to reduce taxable income, says Weltman.
“If you work out of a home office and your expenses were actually higher than the income you earned in the home office, you can carry over the deduction to a future year,” Weltman says. However, this only works if you use the actual expense method, since there’s no carryover for the simplified method. Your carryover amount can be found on your previous year’s tax return at the bottom of Form 8829.
If your business wasn’t profitable and you had an operating loss, you actually have the option to either carry back the loss for two years (for a tax refund), or carry forward the loss for up to 20 years to offset your future taxable income, with no limit on the amount you can deduct. Doing a carryforward makes sense if the taxpayer was in a low tax bracket in the carry-back years but expects to be in a higher tax bracket going forward, Weltman says.
Whether it reduces the business’s taxable income or the business owner’s personal income depends on the company’s corporate structure. It’s best to consult an accountant or a tax professional for further guidance.
3. Startup expenses
You may be able to deduct the expenses paid to start your business, such as advertising, transportation, consultant fees, travel, employee training and wages, and legal and accounting fees.
You can deduct up to $5,000 in qualifying startup costs and up to $5,000 in organizational costs. Both deductions phase out when your total startup expenses or organizational costs hit $50,000. Each $5,000 deduction is reduced by the amount in startup costs that exceed $50,000.
If you have more than $55,000 in expenses, no first-year deduction is allowed and you’ll need to amortize all your startup and organizational costs over the next 180 months of operation, according to the IRS.
4. Losses on bad debts
Is there any money owed that your business can’t collect, such as unpaid accounts receivable or advance wages to an employee who quit? It may not be a total loss for your business because it may be a deductible expense.
The IRS defines a bad debt as one that was created or acquired in your trade or business, or closely related to your trade or business, when it became partly or totally worthless. Types of bad business debts include loans to clients, suppliers, employees or distributors, and debts of an insolvent partner. They become bad debts only after you’ve tried to collect on them for a reasonable period of time and you’ve taken “reasonable steps to collect the debt but were unable to do so,” according to the IRS.
You can claim a deduction for a bad business debt only if you previously included the amount owed to you in your gross income, according to the IRS.
5. Tax, legal and educational expenses
In general, the fees paid to your accountant, lawyers or business consultants that are “ordinary and necessary expenses directly related to operating your business” are deductible in the tax year they were paid, according to the IRS. However, legal fees that are paid to acquire business assets are not deductible.
Other eligible deductions may include tax-preparation fees paid in the previous year, licenses and regulatory fees paid to state or local governments, and expenses paid for the cost of education and training for your employees.