Small Business Tax Deductions: What You Can Write Off

What makes an expense deductible

The IRS generally allows expenses that are ordinary and necessary for your trade or business. They must be tied to the business and documented.

"Ordinary" means common in your industry. "Necessary" means helpful and appropriate for the business. Personal expenses do not qualify, and mixed-use items such as a phone or a vehicle can be deducted only for the business share.

A deduction lowers taxable income, not the tax itself. If your profit is $80,000 and you have $10,000 of additional legitimate deductions, you are taxed on $70,000. Whether a given expense qualifies depends on facts, so check IRS publications and your accountant for the current rules.

If you are unsure about an expense, record it with a note and ask your preparer at year end rather than guessing.

Everyday operating expenses

Most small businesses deduct rent, utilities, supplies, wages, insurance, professional fees, software and advertising in the year they are paid or incurred.

• Occupancy: rent, utilities, repairs and maintenance
• People: wages, payroll taxes, contractor payments, some benefits
• Operations: supplies, inventory purchased for resale (through cost of goods sold), shipping
• Professional services: accounting, legal, consulting
• Marketing: website, ads, printing, sponsorships
• Insurance and licenses: business policies, permits, registration fees
• Interest and fees: business loan interest and bank fees

Your accounting method decides the year. Cash-basis businesses generally deduct when paid; accrual businesses when incurred. See our guide to business expense categories for setting up categories.

Vehicles, travel and meals

Business driving can be deducted using either actual costs or the standard mileage rate. Travel and meals have specific limits and record rules.

For vehicles, keep a mileage log with date, destination, purpose and miles. You can generally choose the standard mileage rate, which the IRS publishes each year, or actual expenses, with rules about when each is allowed. Commuting does not count.

Business travel deductions cover transportation, lodging and, in many cases, meals, when the trip is primarily for business. Meals are generally limited to a percentage, and entertainment is mostly not deductible. Rules shift, so confirm the current percentages with the IRS or your accountant before you plan.

Home office, equipment and depreciation

A regularly and exclusively used home office may qualify. Equipment can be deducted through depreciation or special first-year elections, within limits.

The home office deduction requires that part of your home is used regularly and exclusively for business, with simplified and actual-expense methods available. Using the dining table does not qualify.

Large purchases such as machinery, vehicles and computers are often recovered over several years via depreciation, but tax law offers elections that can accelerate some of that in the year you buy. Limits and eligibility change, so ask your accountant before buying with taxes in mind. Do not buy something you do not need merely for the deduction; spending a dollar to save a fraction of a dollar still loses money. Read the depreciation guide for the concept.

Deductions and credits owners often miss

Retirement plan contributions, health insurance for the self-employed, the qualified business income deduction and certain credits may reduce your bill, if you qualify.

Ask your accountant about:

• Retirement plan contributions, such as a SEP IRA or solo 401(k)
• Self-employed health insurance premiums
• The deduction for part of self-employment tax
• The qualified business income deduction for some pass-through owners
• Start-up and organizational costs
• Credits for hiring, energy improvements or research, where applicable

Credits reduce tax directly and can be worth more than deductions. Our article on the most important tax credits for small businesses covers some of them. Eligibility and limits change often.

Records that protect your deductions

Keep receipts, invoices, bank statements, mileage logs and notes on business purpose. Without records, deductions can be disallowed in an audit.

1. Use a separate business bank account and card.
2. Photograph receipts the day you get them and file them by category.
3. Note the business reason on anything unusual, such as a client meal.
4. Reconcile accounts monthly.
5. Keep records for as long as your accountant advises; the IRS publishes retention guidance.

Good records also help when you seek funding, since clean statements show real revenue and cost patterns. See what your preparer will need in what your accountant needs to file your taxes.

Taxes, cash flow and big purchases

A deduction lowers tax only by your tax rate, so a purchase should still make business sense on its own. Plan cash for the tax bill and for investments.

Illustrative example: you buy a $20,000 machine. If your combined tax rate on the extra profit is 30 percent, a full deduction saves up to $6,000, but you still spent $14,000 net. The purchase pays off only if the machine earns more than that.

If a purchase makes sense but your cash is tight, equipment financing through ROI Funder's network spreads the cost over a schedule, while working capital can cover tax payments or timing gaps. ROI Funder considers 6+ months in business, $20,000+ monthly revenue and 500+ FICO. Talk to your accountant about the tax effect of any financing.