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If you have a certified accountant working for you, there's probably a whole list of business expenses already crossed off from your taxable income. While knowing what costs you can write off can be challenging, doing so is extremely important. It can help you pay lower taxes or pursue a refund from the IRS.
You can write off any expenses incurred while producing an income for your business. These include travel, medical, real estate, home office expenses, and health accounts contributions. Others are charitable donations, mileage, and education expenses. These deductions help lower your tax liability.
If you are unsure what deductions you can write off for your business, and you don’t have an accountant on your payroll, keep reading. This article will help you understand what you can write off and what you can’t, and why.
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Why You Can Write Certain Deductions Off on Your Taxes
For a business expense to be considered deductible, it needs to be ordinary as well as necessary.
Ordinary expenses refer to costs that are both common and acceptable in the industry, while necessary expenses are those that are helpful and appropriate for your trade. Note that an expense can be considered necessary even if it’s not indispensable.
Still, every deduction comes with its own rules and limitations.
These are necessary to provide guidelines on how much you can deduct and when. In general, you can deduct a business expense in full if it’s not a capital expense and meets the ordinary and necessary criteria.
One thing to note, though, is that while some tax deductions remain the same year after year, others change while new ones come up every so often. It's therefore essential to keep checking for fresh additions or changes to existing deductions.
You might need to hire a tax professional to help you claim the deductions if you’re not comfortable using tax software or following IRS guidelines. This is because the different deductions appear on specific tax forms, so you ought to know exactly where to file them.
Now, let's explore the various business expenses you might qualify to write off from your taxes next.
1. Business Travel Expenses Deduction
If you regularly travel for work, you might be eligible to subtract ordinary and necessary expenses incurred while you travel for work. These expenses might include transportation, airfare, meals, and accommodation.
2. Car for Business
You can deduct the costs related to running your car if you use it for business purposes. As such, you can use a standard mileage rate or pick the actual expense method.
The actual expense method indicates the actual costs incurred when operating your car for business needs.
3. Charitable Deduction
You can deduct any charitable contributions you have made in money or property up to $300.
For cash donations, you may deduct up to 60% of your adjusted gross income. You can either claim the amount on Form 1040, line 10b without itemizing, or use Schedule A if itemizing the deduction.
The latter applies if you’ve made significant donations in items and property and desire to deduct more than $300 using the official deduction for charitable contributions.
These expenses fall under itemized deductions. But for 2020/2021, if you contributed to qualifying charitable, scientific, or educational organizations due to Covid-19, you can claim the $300 plus the standard deduction without itemizing.
Out-of-pocket expenses also qualify. So, if you bake pies for a charity fundraiser, you can deduct the ingredients' costs.
4. Continuing Education Expenses
You can deduct up to $4,000 in tuition and fees expenses incurred when pursuing continuing education to improve your skills and maintain licensing. To claim this deduction, you need to fill in Schedule 1 and Form 8917.
No itemization is necessary when claiming the fees and tuition deduction.
5. Home Office Deduction
The IRS allows you to deduct expenses that are directly related to working from home. This means that if you use a portion of your home exclusively to conduct business, you could deduct your home office as a business expense.
Also, your home must be the principal location for your business.
So, if you worked from home regularly within 2020, you can deduct costs covering utilities, rent, repairs, security, and renter's insurance. To claim this deduction, fill in Form 8829 and Schedule C.
6. Contributions to a Health Savings Account
Health savings accounts (HSAs) form tax-exempt accounts that you can use to reimburse or pay for specific medical expenses. These contributions are made with after-tax dollars, which makes the deduction unavailable for donations made directly from your paycheck.
For contributions made into your account, you can claim a tax deduction of up to $2,700 every year.
Contribution limits vary depending on your age, high-deductible health plan, and when you become eligible. If you qualify for the tax deduction, claim it on Schedule 1.
7. Medical Expenses Deductions
You can write off qualified medical and dental expenses for yourself, your partner, and dependents that go above 7.5% of your adjusted gross income.
Such costs can cover renovations or improvements for medical purposes made out of pocket.
For instance, if you install wheelchair ramps or lower cabinets for easier access, you can write this expense off your taxes. Also covered are costs like doctor or specialist fees, hospital care, and insulin payments.
However, funeral expenses, cosmetic surgery, and over-the-counter medications aren’t deductible.
Since you need to itemize this deduction, it only qualifies for deduction if the sum of all your itemized deductions isn’t higher than your standard deduction. In 2020, the limit for joint filers was $24,800 and $12,400 for single filers.
But as a self-employed business owner responsible for your health insurance coverage, you could deduct 100% of your premium cost. You can take this deduction off your adjusted gross income instead of taking it as an itemized deduction.
8. Mileage Reimbursement Deduction
The mileage reimbursement deduction typically covers fuel.
Nonetheless, it can also include parking, car insurance, and maintenance fees. The tax write-off allows for a deduction of 57.5 cents per mile, but your expenses must be 2% above your AGI for you to qualify.
You’ll need to complete Schedule 1 and Form 2106 to claim this deduction.
9. Mortgage Interest Deduction
The mortgage interest paid on your business property is an allowable deduction. With this deduction, you may deduct the interest and payments on your private mortgage insurance.
While this is an itemized deduction, after the 2017 tax reform, itemization no longer applies.
The IRS caps the deduction limit at $750,000 for mortgage debt incurred after 15th Dec 2017 and up to $1 million if you got your mortgage earlier.
10. Interest on Investment Property Loan
If you took out a loan to purchase an investment property, you could write off the interest payable on that loan by itemizing the deduction. The deduction applies to loans on investment properties, but excludes securities, stocks, or bonds that produce tax-exempt interest.
11. Pension Expenses
Contributions made to retirement savings also qualify as tax-deductible business expenses and appear on Schedule 1.
These entail all contributions to retirement accounts covered by retirement plans such as the traditional IRA. So, if you contributed to a traditional IRA with after-tax dollars, you can claim the IRA deduction for the tax paid.
The amount you can deduct from contributions made to a traditional IRA depends on your salary. The IRS doesn’t permit tax deductions on contributions for Roth IRA, though.
In 2020 and 2021, the maximum amount you can contribute to a traditional IRA is $6,000.
12. State, Local, and Foreign Income Tax Deduction
You can claim foreign, local, and state income taxes as itemized deductions, which include state and local sales taxes as well as real estate taxes. Thus, you can write off mortgage interest and insurance premiums paid for your home during the tax year.
Other expenses that could make allowable tax deductions are local or state personal property taxes, but only if the said amounts are based on property value. Property tax and state income tax have their upper limit capped at $10,000.
13. Business Meals and Gifts
The 2017 tax reforms excluded entertainment expenses as deductible business expenses and limited meal deductions to 50%. But in 2021, business meals and beverages are now 100%, which includes takeout and delivery.
Gifts used for business purposes are deductible either in full or partially, depending on the business circumstances.
What Are Tax Deductions?
Tax deductions are expenses you can legally deduct from your taxable income, thereby lowering your taxable income and, consequently, your tax liability. These deductions are designed to encourage certain activities, including investing in a trade or contributing towards a retirement account.
The expenses usually occur within the tax year, and to write them off, you subtract them from your gross income. Doing so also allows you to figure out the exact amount of tax you owe.
For instance, if you operate a small business, the law allows you to deduct the costs you incur to operate your business profitably. The Internal Revenue Service (IRS) doesn't exactly provide a list of tax deductions you can write off.
However, the tax principle in Code Section 62 indicates that any expense you incur while producing an income constitutes a valid write-off.
This essentially means that with the proper business purpose, you could convert even personal expenses to business expenses.
For experienced small business owners, it's relatively easy to identify expenses with a legitimate business purpose. Indeed, most of them almost always consider an item's tax purpose before purchasing it.
Types of Tax Deductions
There are two types of tax deductions:
- Standard deductions
- Itemized deductions
As a taxpayer, you can choose to go for either itemized deductions or claim standard deductions that correspond to your filing status.
Let's look at each one of these methods of claiming tax deductions briefly.
A standard deduction is the portion of your income that's not subject to tax. What's more, you can apply this amount to lower your tax bill.
This deduction usually applies if you choose not to itemize your deductions in order to calculate your taxable income on Form 1040, Schedule A. Your age, filing status, age, and whether disabled are some of the factors that determine the amount of standard deduction to take.
Itemized deductions comprise costs that you can deduct from your adjusted gross income (AGI). The tax deductions you qualify for help lower your taxable income, thereby reducing your tax liability.
However, the amount you save depends on your tax bracket, plus you must list the specific costs on Form 1040, Schedule A. Furthermore, the deductions only apply for amounts above the standard deduction limit.
Examples of itemized deductions that fall under business expenses include travel, networking, and transport expenses.
Which option should you go for? Here is a useful recommendation:
- Standard deductions: Claim a standard deduction if your standard deduction is higher than that of your itemized deductions.
- Itemized deductions: Choose this option if your standard deduction amount turns out to be less than the total of your itemized deductions, which will help you save money.
Still, there are other considerations you need to be aware of before making your final choice:
- Itemizing deductions takes a lot of time. You need to fill out many forms, and you also need to prove that you qualify to claim the deductions. Therefore, it's essential to save all your receipts as proof of your expenses, including your bank statements, medical, insurance, and tax receipts. Receipts are also crucial for audit purposes.
- Taking a standard deduction is much faster, as there are no calculations to do. Besides, it’s a taxable income automatic deduction you can receive without itemizing any deductions.
Every business owner likes to save money, but different businesses present unique tax situations.
To make the most of your tax deductions, make a habit of tracking all your business-related expenses. A careful examination of each expense will ensure you never miss out on claiming a legitimate deduction, allowing you to pay the lowest tax possible.
Remember to claim all the tax deductions you qualify for every time you file your income taxes. For itemized deductions, ensure to learn which business expenses you can deduct and then keep the appropriate records safely.
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