Small Business Tax Deductions Explained

Small business tax deduction tips

As a sole proprietor or founder of a small business, it can be difficult to navigate the waters of the IRS annually and somehow take maximum advantage of the small business tax deductions available.

Though you can and should utilize the services of tax professionals and software, it is always good to have a basic understanding of how to prepare your small business for tax season. Personal taxes can be complicated enough; filing as a business can be downright overwhelming. But, if you’re willing to sift through the paperwork and read the fine print, you can save a lot of money in the form of tax deductions.

Here are some basics of tax tips on deductions for small businesses.

Tax Deduction #1: Home Office

Many small business owners are afraid to claim home office deductions for fear it will bring the auditor a-callin’. Fear of an audit should never keep you from claiming legitimate deductions. Just make sure you keep well-organized records, and that you can prove your deductions are indeed for business expenses and you’ll be fine. Here are some pointers when it comes to home offices.

  • Make sure that your office is distinct from your living area. Whether it is a room of its own or a part of a larger space, there should be a clear line between your workspace and the rest of the home.
    • If your home office is part of another living space, measure a reasonable amount of square footage around your workspace to determine the size of your “office.” 
  • If you only have one computer, claiming it as an office computer will be difficult. No auditor will believe that it is not utilized for personal use as well. The burden of proof will be up to you, so either dedicate a computer solely to work or omit the computer area from your office space.
  • A percentage of your house expenses (electricity, internet, water, etc) are tax-deductible towards your business.
    • To determine the percentage of home expenses that are deductible for your business measure your work area and divide it by the square footage of your home. That percentage is the fraction of rent, mortgage, utilities, taxes, and maintenance you can claim.

If you want more help determining your home office tax deductions, review this form from the IRS. 

Tax Deduction #2: Business Equipment and Supplies

Up-and-coming businesses need to be up-to-date on their technology, and Uncle Sam does not hinder this. Under Section 179 of the tax code, equipment expenses such as computers, printers, and even company vehicles are tax-deductible, up to a certain amount. Depending on the item, you can deduct the full cost on the year of purchase, or split it between several years.

Business-related software also qualifies under Section 179. So don’t be afraid to get the technology you need to perform necessary business tasks. Just be aware of the amount you can deduct under section 179 because it changes yearly.

Also, if you only have one car, you can’t justify that as purely a business vehicle. Don’t try to use the fact you have a business to pad your personal belongings. If you’re going to purchase a work vehicle, make sure it is only used for work.

Subscriptions to business-related websites and magazines are fully deductible. Combined with the conference deductions (discussed below), there is no reason not to stay informed in your field. 

Tax Deduction #3: Travel Costs, Meals, & Entertainment

Owning a small business and traveling for work is a dream for many entrepreneurs. Since travel can be necessary for business success and expansion, many of the expenses are completely tax-deductible. Our tax tip on travel is to write off expenses like airfare, hotel fees, car rental and mileage, and travel expenses like laundry costs. Food is only deductible up to 50%, probably because the government figures you would have to eat whether you were traveling or not. Remember these points when deducting business travel expenses:

  • Feel free to take your family with you, but only the costs for you, and only those that are business-related, can be deducted.
  • The standard mileage rate from the IRS can change each year (or even mid-year like it did in 2022) to reflect current gas prices. So make sure you are tracking mileage and the date the trip was taken. 
  • If you’re taking clients out for a meal, those costs are 50% deductible, just make sure to write on the bill/receipt the reason for the meal. For example, “investment meeting with Jane Doe from Doe Enterprises.” This makes it easier for you to keep tabs, and easier for any auditors that happen upon your files. While no one wants an audit, if one does come your way, the more prepared you are, the less unpleasant the experience will be. 
  • Conference fees are deductible as long as the conference is directly useful for your business. If it’s a conference related to your industry or will help you run your business more smoothly, then it probably qualifies. If the purpose of going is to earn money on the side, then it’s not as impactful to your business and is not as likely to qualify. And of course, fan conventions and other entertainment-based events do not count, even if there are lectures. 
  • Entertainment such as amusement parks, tourist attractions, and the like are not deductible. You can definitely combine business and pleasure, just don’t include the pleasure expenses in your deductions. If you are going for a business-related purpose, you may be able to write off the expense, but sometimes it’s safer just to call a good time a good time and save the write-offs for less ambiguous ventures.

For more help determining tax-deductible business travel items, visit the IRS website here.

Tax Deduction #4: Professional Development

The costs of continuing education and professional development courses can be deducted as business expenses. This includes things like conferences, workshops, or webinars. These expenses can help you stay current in your field and improve your skills, which can ultimately benefit your business.
These deductions can also include:
  • Professional development books
  • Subscriptions to industry-related magazines or publications
  • Online or in-person classes 
The classes must directly relate to your industry and current line of work (not another dream job you’d like to have) in order to qualify as a business deduction. 

Tax Deduction #5: Health Insurance Premiums

If you pay for your own health insurance as a freelancer, you may be able to claim a deduction for the premiums you pay. This can be a significant expense for freelancers, who often don’t have employer-provided health insurance. 

Tax Deduction #6: Retirement Contributions

Contributions to a retirement account, such as a traditional or Roth IRA, can be deducted from your taxable income. This is a great way to save for the future while also reducing your tax bill.

Tax Deduction #7: Business Insurance

If you have insurance for your freelance business, such as liability insurance, you may be able to claim a deduction for the premiums you pay. This can protect you in case of a lawsuit or other legal action related to your business.

A Note About Tax Deductions

When it comes to tax deductions, it’s important to keep in mind that a deduction does not translate to a direct decrease in your taxes owed. If you have a $500 deduction, that does not mean you pay $500 less in taxes.

Instead, it means that you subtract $500 from your earned taxable income, lowering the proportion of your income that you pay taxes on. If you have significant enough deductions, you can move down a tax bracket. However, that depends on your total deductions and current income. 

It’s also important to keep in mind that the standard deduction is $12,200 for single filers and $24,400 for married filers. If your total donations and deductions for a year do not exceed the standard deduction, it may not be worthwhile to itemize and deduct donations.

As always with finances, especially taxes, it’s important to keep your receipts and details about the reason for purchases. While doing this for every purchase may seem over-the-top, it’s easy once you get into the habit of it. It will also save you a lot of grief if you get audited, and it will help you keep peace of mind that your finances aren’t going to get your business in trouble. The last thing you need is a pile of debt to the IRS.

It’s never profitable to leave money on the table. The cost of running and maintaining a business is high, but many of those costs can be reduced by filing your taxes knowledgeably. Do your research, take the time to do your taxes correctly and completely, and put the money you save back into your business.

A man opening his car door and smiling. Small business owners can donate their car as a tax deduction.

A Lesser Known Tax Deduction: A Car Donation

If you’re thinking about getting rid of your car, you have a few options to do so. You can try to junk or recycle it if it’s in bad condition. You can try to find a buyer if you think someone would be interested in it. But if you’re feeling generous, you might decide to donate your car to a charity in need.

Hundreds of thousands of Americans donate their cars every year to charities big and small.

From helping low-income families get affordable transportation to providing funds for your local public radio station, there are countless ways that donating your car can help. 

What makes vehicle donation such a popular avenue to choose? Factors include ease of disposal and the good feeling that comes from doing something charitable.

However, there’s a second benefit as well: if you donate a car correctly, you can claim a tax deduction when you file. 

What Taxable Benefit is There for Donating a Car?

How much an individual benefit from a car donation depends heavily on their diligence throughout the process. If you donate your car and the charity sells it for less than $500, you can deduct either its fair market value or $500 — whichever amount is smaller. 

If the charity you donate your car to sells the vehicle for more than $500, you can deduct the full total they sold the car for, but you’ll need to do more paperwork. 

Charities can sell vehicles at auction, but they can also use them for internal purposes or provide them to people in need of low or no cost. If they sell the car, you can claim a deduction for the full amount that the car is sold for on your taxes, and the charity gets those funds to add to its coffers.

If they keep it for internal use, donate it or sell it to someone in demonstrable need at a reduced price, you can claim the fair market value for the vehicle instead of whatever it actually sold for. The fair market value for the car might be higher or lower than its sale price.

No-Haggle ‘Sale’

Compared to selling a car privately or to a junk car service like CarBrain, a vehicle donation typically doesn’t provide the same financial benefit. One of the most popular reasons people continue to choose to donate cars is the simplicity of the process.

Selling a car can be frustrating and time-consuming, with tire-kickers and hagglers slowing down the process. With car donations, the process is hassle-free and extremely fast. The organization receiving the car does virtually all the work. All you have to do is claim the deduction on your taxes.

Income Tax Receipt

Despite getting no cash in hand whatsoever from a car donation, donors can reduce their income tax using the car’s declared value or final sales price. For deductions of more than $250, it’s important to get documentation from a charity acknowledging the donation of the car.

What’s Required When Donating a Car

Each party has responsibilities in a car donation that is mandatory.

  • The donor may only claim the actual sale value for the vehicle, even if it was sold for less than fair market value unless it was sold to a needy individual.
  • The contribution must be itemized on your Schedule A of form 1040
  • Donations cannot exceed 50% of your adjusted gross income.
  • For vehicles worth more than $5,000, you must fill out Form 8283 and obtain a written appraisal.
  • The charity carries the bulk of the obligations, however.
  • They must provide a written donation acknowledgment that includes the donor’s taxpayer ID number, name, the vehicle’s VIN number, and a standardized declaration.
  • A written receipt for the contribution’s value, including the sale price, must be provided within 30 days of the donation, or a 1098-C can be filled out.
  • If you must file form 8283, the charity must also file Form 8282 and provide you with a copy.

What to Watch for in a Car Donation

  • Many popular, reputable charities exist that receive vehicle donations to help improve their financial position. However, not all organizations are knowledgeable or diligent about requirements. It’s a field that allows for scams or less-than-reputable practices since money isn’t physically changing hands.
  • Watch for organizations that tow vehicles away without first providing a receipt. It may be nearly impossible to retrieve the documents you need if the process isn’t documented.
  • If your car is worth more than $500, ensure you get documentation within 30 days of the donation for its actual sale price, or you may be limited to just $500 in value.
  • Make sure the organization is a 501(c)(3) organization by checking with the IRS EO Select Check website. Only donations to registered tax-exempt organizations qualify for tax deductions.
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