Businesses and startups may not pay enough attention to expense deductions in their financial planning processes, and that could be costing them money. The costs of operating a business and producing sales are known as business expenses. Given this broad requirement, the IRS does not offer a comprehensive list of allowed startup and business deductions.
A few simple changes could considerably lower your tax obligation.
Consider the scenario where you drive your vehicle 100 miles every week to deliver goods to your customers and pick up supplies, that’s 5,200 miles in a year eligible for tax deductions you might be missing. Maintaining a log that separates work and personal use may seem time-consuming, but if you don’t take advantage of that deduction, you are missing out on over $2,900 in deductions.
Or perhaps you closed your office and began managing your business from a spare room in a home you own. You can typically write off up to $1,500 for space that is utilized solely for business along with other utilities.
An expense is deductible if it is “ordinary and essential” for operating a business in your sector.
It is therefore very worthwhile to structure your expenditures so that your company can take advantage of all legal write-offs, develop an efficient financial plan, pay the correct amount in quarterly taxes, and avoid worrying about an audit.
Why Business Tax Categories Are Important?
1 – Better Tax Filing Method
It is more accurate to file your taxes accurately and costs less money to do so when you categorize and maintain track of your business spending for tax purposes.
For instance, your tax preparer will spend hours sifting and categorizing your receipts into the appropriate IRS categories if you (figuratively) provide him a shoebox full of them.
The more assistance you provide, the less time it will take your tax preparer to do your taxes (and charge you), including calling you to inquire about specific expenses you’re deducting.
2 – Advance Planning for Taxation
After you have completed the first planning phase to establish your bookkeeping and accounting records, sit with your tax preparer to determine whether the system you’re going to employ will make it simpler or more difficult for her to accurately do your taxes each year.
Your preparer may be able to offer you more beneficial advice, such as altering the method you depreciate specific assets depending on your revenue or loss estimates, in addition to ideas for greater accuracy.
How To Categorize Business Taxes
The process of categorizing your business expenses is pretty straightforward, but many small business owners put it off until it is required, which adds to the workload.
Remember, you will need to have an exact estimate of your normal business expenses and the right categorization whether you are searching for investors, external financing, or need to generate financial projections.
Here are some suggestions about how to simplify the procedure:
- Step 01: Create expense accounts that accurately represent your business.
- Step 02: Invoices from vendors with the appropriate expense account code.
- Step 03: Replace spreadsheets with accounting software.
Different Business Tax Categories
Category 1: Income
Wages, Salary, Tips, Bonuses
Tax-deductible expenses include employee salaries, gross wages, commissions, bonuses, and other forms of compensation.
If payments were made via payroll and the recipients supplied services for your company, compensation may even extend to salaries paid to wives and children.
There is a requirement that the payment is deemed reasonable.
IRA/Pension distributions
A wonderful approach for self-employed people to lower their taxable income is to make contributions to tax-advantaged accounts like an IRA or 401k.
Foreign Earned Income
The overseas earned income exclusion, also known as the foreign earned income exclusion, may be available to you if your company is situated abroad.
You must fulfill specific standards, such as earning less than a particular amount.
Category 2: Deductions
Mortgage Interest
You might be able to write off the interest paid if you loan money to build something new or upgrade your house for commercial use.
Real Estate Taxes
You might be able to deduct part of the taxes you pay if you itemize your taxes and work from home.
Property Taxes Paid
Property taxes paid on one’s primary residence and any additional real estate owned by the taxpayer are deductible for homeowners who itemize their tax returns. This includes any property taxes you have to pay ever since the day you buy the house.
Category 3: Exemptions
Medical Expenses:
Self-employed people who cover their insurance premiums or medical costs can write these costs off on their tax returns. Examples include medical costs and prescription medications.
Books and Magazines Subscriptions:
Specialized publications that pertain to your business, such as magazines, books, and journals, may be tax deductible. Newspapers, for instance, might not qualify, but trade journals might.
Child or Dependent Care
You can deduct qualifying expenses for the child or dependent care as long as you comply with the IRS regulations.
Category 4: Miscellaneous
Alternative Minimum Tax
Nonrefundable personal tax credits, such as dependent care and foreign tax credits, can be used to offset any AMT liability. If you had previously paid AMT, you might also be eligible for a minimum tax credit.
Estimated Tax Payments
Any projected taxes paid to state or local governments as well as any state or local income taxes from a previous year may be written off as long as they were paid during the tax year.
Household Employee (Nanny) Wages
As long as the nanny is paid legitimately, the child is under the age of 13, and both spouses are employed, a taxpayer may partially deduct nanny expenses.
The two most common ways to use this tax benefit are through a dependent care flexible spending account or as a tax credit when paying income taxes.
Most Common Non-Tax Business Expenses
Understanding the differences between taxable and non-taxable expenses can be challenging. You can have a different list of itemized deductions that employees can use to reduce their taxable income depending on your firm.
If you are unsure, the most crucial thing you can do is to understand the distinction between personal spending and corporate expense.
Personal expenditures and activities are not eligible for tax deductions. As well as any political donations, travel expenses, and gifts worth more than $25. Though sometimes they appear to be related to business, sometimes they are not.
Check your company’s taxable and non-taxable expense policy if you’re still unsure of which costs are excluded. It will describe all the different expenses that an employee is eligible for reimbursement as well as how to file a claim.
Frequently Asked Questions
What is a tax-deductible business expense?
The expenses can be deducted depending on the type of business you have. Start by reading Internal Revenue Service Publication 535, which covers general tax filing guidelines as well as the deductibility of typical business expenses.
An organization driven by profit must incur those “ordinary and necessary” costs.
Even if your small business is struggling financially and isn’t making a profit, the intention must be there. If not, the IRS might think your firm is just a hobby and won’t let you claim costs.
To ensure accuracy, the IRS also advises separating regular company expenses from those that come under the cost of goods sold (COGS) and capital expenses, as some business expenses cannot be written off in the year they are incurred.
Are job expenses deductible?
Before 2018, workers may write off the cost of work-related expenses that their employers did not cover. Employee business costs are no longer tax deductible for the year 2018 and thereafter. If the company reimburses the employee, they are deducted from wages, nevertheless.
What is the best accounting software that I can use?
Even while it is feasible to manage expenses using a spreadsheet or a list of business expenses, having the ability to quickly extract those expenses will be helpful when it comes time to file your taxes.
Additionally, you have the assurance that, should you ever be audited, you have a reliable audit trail and enough backup.
The top accounting software programs for managing your company’s expenses are Zoho Books, AccountEdge Pro, FreshBooks, and QuickBooks Online.
Conclusion
Remember, every tax circumstance is individual, and it’s always in your best interest to speak with a CPA who knows the ins and outs of your business before claiming any deductions.
Now it’s time for you to select how to track spending throughout the year now that you have a helpful checklist that contains the typical IRS business expense categories.
Moreover, consuting with a tax specialist is the most critical step you can take. A tax consultant brings years of expertise to apply on your financials and can make you to save money.
