What is the difference between a tax deduction and a tax credit?
Both tax deductions and tax credits can lower the amount of taxes owed for individuals and businesses. Deductions and credits, however, work differently. A deduction reduces the income subject to taxes, whereas a credit lowers the amount of taxes owed. Both deductions and credits are available to all tax filers.
How do I claim tax deductions?
Many small business owners and entrepreneurs will claim business deductions by completing Schedule C to IRS Form 1040 or Form 1040-SR. You can file paper tax returns or electronically, but you must file to claim the deductions.
Business taxes, tax rates, deductions, and credits are complex. To claim deductions, credits, or most tax relief or incentives, you typically are required to qualify for and request these. Your tax professional can help you claim the tax write-offs that are available to your business.
What constitutes a deductible expense under IRS rules?
In IRS Publication 535, "business expenses" are defined as “the costs of carrying on a trade or business.” Qualified expenses can generally be deducted as long as the business is operated to make a profit. Not every expense, however, qualifies as a deduction. Deductible expenses are both “ordinary” and “necessary.”
Ordinary expenses are common and accepted expenditures in your industry. Necessary expenses are appropriate and helpful to operate your business. An expense does not have to be indispensable, however, for it to be considered necessary.
There are a few categories of expenses for business owners, such as income and succession taxes, that are not deductible, even if they are common. These include federal income taxes paid, state inheritance, legacy, and succession taxes, and estate and gift taxes.
What are common small business tax deductions?
It probably does not come as a surprise to learn that you may deduct the cost of office supplies and operating costs for any type of business, and we include rental property owners here. Similarly, marketing and advertising expenses, including promotional items like website design and maintenance, property listings for landlords, business cards, and even logoed coffee mugs, are regularly deducted.
Self-employed individuals can deduct their landline and cell phone bills as well as the cost of internet connectivity. If you have a dedicated phone line for your business, you can deduct the entire amount. Similarly, if you have dedicated commercial space, your internet bill for that location can be deducted. If you do not have a dedicated business phone line or internet connection, you can still deduct a percentage based on business use.
Another fairly common business deduction is business travel, meals, and entertainment expenses. You can also deduct an employee’s business travel expenses or meals, even if the employee is your spouse or child. For the 2023 tax year, you can deduct 50% of qualified business meals. In 2022, the IRS offered an enhanced meal deduction of 100% of qualified business-related meals provided by a restaurant.
Of course, you will need to determine which deductions apply to your specific business and situation. Rocket Lawyer can now match you with a tax pro to help you do just that.
What are some lesser-known tax deductions for small business owners?
There are several other categories of business-related expenditures which are tax-deductible. Many freelancers and small business owners can deduct one-half of their self-employment taxes paid on their income tax returns.
You may also take a tax deduction for interest payments on credit cards or business loans, if the underlying expenses were ordinary and necessary business expenses. The credit card or loan, however, must be in your own name. You cannot take a deduction for interest on someone else’s credit card, even if the underlying purchase was for your business. Rental property business owners may deduct mortgage interest and real estate taxes.
Tuition, books, supplies, transportation, lab fees, and other expenses for professional development, either for you or for an employee may be deducted.
Another less-known tax deduction is for retirement plans as a small business owner. If you contribute to a solo 401(k) retirement account, you can take a tax deduction for your contribution of up to $66,000 in 2023. This contribution limit increases annually. For 2024, it is $69,000.
What is the qualified business income deduction?
Many sole proprietors and small business owners can take the qualified business income (QBI) tax deduction. For single individuals with taxable income no more than $182,100 for 2023, or $364,200 for married taxpayers, the QBI provides a 20% deduction on taxable business income. Some business owners with more income may still take a lesser deduction, depending on the business.
This deduction, which was available for the first time in the 2018 tax year as part of the Tax Cuts and Jobs Act, is designed for businesses, including sole proprietorships, LLCs, partnerships, and S-corporations, with pass-through income. The QBI is not technically a business tax deduction. It is a personal deduction for individuals with pass-through business income.
Are tax deductions available for different types of insurance?
Yes. In general, you may deduct the cost of any business insurance policy, such as professional liability or property insurance, as long as it meets the ordinary and necessary test.
Some small business owners and entrepreneurs may deduct health and dental insurance premiums. Long-term care insurance premiums may also be tax-deductible. You can only deduct health and dental insurance premiums if you are not enrolled in an employer-sponsored plan. Still, even if enrolled in an employer-sponsored plan, any out-of-pocket medical expense in excess of 7.5% of your adjusted gross income may be deducted.
Confused about what you can and can't deduct for your particular business and situation? Get matched with a tax pro via Rocket Tax™ to save time and money filling your tax returns.
Can I take a deduction for using a home office?
Yes. If you lease separate office, retail, or warehouse space, you can deduct the rent. If part of your home is a dedicated office for your small business, you can also deduct some of your related home office expenses. Specifically, you can deduct a portion of your mortgage interest or rent payments, utilities, property taxes, maintenance, and other costs.
The space needs to be used regularly and exclusively for your business. So, if you use your dining room table to complete business activities in between meals, it would not qualify for the home office tax deduction. But, a separate, dedicated office space would qualify.
If your home office is 7% of your total square footage, then 7% of your housing expenses, including real estate taxes, are deductible. There is also a simplified home office deduction option for small business owners, which allows for a flat $5 per square foot up to 300 square feet. This option can simplify your record-keeping requirements, but it might result in a smaller overall deductible amount.
Can I take a deduction if I use my personal vehicle for business purposes?
You may be eligible to take a tax deduction for your vehicle, even if it is not dedicated to business purposes. As with the home office tax deduction, there are two options for claiming a deduction for car expenses.
Under one option, you document business mileage as opposed to personal mileage. You can claim a flat amount for each mile driven for business purposes, multiplying the number of business miles by the IRS standard mileage rate. For 2023, the mileage rate is $0.655 per mile.
The second option involves tracking actual expenses based on the business use of your vehicle. This includes gas, oil, maintenance, tolls, parking, auto insurance, registration fees, maintenance and repairs, and even lease payments, although there are additional rules about deducting lease payments. While this method can be more labor intensive and require more documentation, it may result in a higher tax deduction.
Am I eligible for any special startup deductions if I started my business in 2023?
Starting a new business can be expensive, but you may take tax deductions for some startup costs. Specifically, expenses you incurred before your business was operational, such as advertising a grand opening, equipment outlays, market and product research, wages to train employees, consulting fees, filing fees, and other costs, may be tax-deductible.
Generally, small business owners can deduct up to $5,000 in business startup expenses and up to $5,000 in organizational costs. The deductible amount, however, is less if startup expenses exceed $50,000. You may also depreciate startup expenses over time, capturing a tax deduction for a period of years after you start your business.
What kind of documentation do I need to keep to support tax deductions?
If you want deductions when you file your 2023 return, the IRS requires documentation to support your claims. Maintaining records all year, rather than scrambling to pull documentation together during tax season, can ease the process.
In addition to maintaining accurate records to support your business income, retain invoices and receipts for bills paid and expenses incurred for business expenses. Mileage logs, mechanic bills, or receipts can document automobile expenses. Your business travel and meals documentation can show who traveled and took part in the meals and the business purpose of the expense. Documentation for repairs and maintenance work done on rental properties may support deductions for rental property owners.
Some deductible expenses highlighted in this guide may not be available for all small business owners. Meanwhile, there may be other deductions not reviewed here, including charitable contributions, memberships and subscriptions, bad debt write-offs, employee wages, employee benefits, and more.
If you have more questions about taxes and your small business, reach out to a Rocket Lawyer network attorney for affordable legal advice. If you are a landlord looking for additional tax information specific to rental property owners, check out the Rental Income Tax Guide for Landlords. Did you know you could save half off your taxes with Rocket Tax™? Just hand off your documents, RocketSign® and done.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.
