US Tax Day is only a few days away! While usually the 15th, the deadline for filing taxes this year is Tuesday, April 18th (the 15th is a Saturday, and the nation's capital observes Emancipation Day that Monday, the 17th). While we are not CPAs (and you should consult your accountant for any tax and financial decisions you make), we have a few tips we've learned over the years. Keep reading for a crash course in tax write offs for your small business!
1) A Tax Write-off is a Business Expense That Lowers Taxes
Did you ever see that episode of Seinfeld where Kramer tries to explain "write-offs" to Jerry? Turns out, neither of the two understood the concept... and many taxpayers experience similar confusion! To break it down for all of us, a tax write-off is an IRS-approved business expense that ultimately lowers your taxable income. The government specifically uses the terms "ordinary" and "necessary" when clarifying what qualifies as a write-off. Basically, the expense needs to make sense for your business and draw a clear conceptual line from cost to relevant benefit. If you have an online business selling homemade crafts, for example, cost of packaging materials could be a write-off: You need to package your items in order to mail them, in order for your business to operate. However, the lunch you ate and TV you had playing in the background while packaging items could not be deducted, as those expenses have nothing to do with the ability of your business to operate. The IRS includes a multitude of types of business expenses to be written off beyond cost of goods sold--we'll dive into those below.
2) Write-offs Are Calculated Using P&L Reports
A Profit and Loss (P&L) Report includes exactly what you'd think it would--your business's yearly profits and your business's yearly losses. To be more technical, the report calculates net profit and loss as costs of products/services and all business expenses subtracted from your business's total revenue and income for the year. There is a wide range of common write-offs in small business P&L reports. It's important to include all relevant business expenses when filing your Schedule C Form 1040 so that you get the most bang for your buck and don't pay more in taxes than you need to! Some of the most common small-business tax write-offs include startup and organizational costs, inventory (cost of products/raw materials, storage, factory overhead, direct labor costs), utilities (water, electricity, telephone, internet), insurance, business property rent, auto expenses, equipment/machinery, office supplies, software subscriptions, advertising and marketing, taxes (yes... your taxes are a tax write-off!), employee salaries and benefits, contracted labor, and legal and professional fees.
3) Talk With Your Accountant About Limitations
As to be expected, there are quite a few concrete limitations and others that need to be discussed with an accountant. Expenses that are not deductible include certain legal costs, fines, or penalties (if you've broken the law, for example); mileage related to your normal commute; personal expenses/activities; and political contributions. There are some expenses that are only partially deductible, as well. For example, meals with clients and employees are typically only up to 50% deductible. Home office deductions also must be broken down. They are calculated either by $5/sqft for business use of the home (up to 300 sqft/$1500) or based on percentage of home used for the business. In either case, in order to qualify for home office write-offs, there needs to be a set, separate room or area that is both 1. dedicated solely to business operations and 2. is your business's primary location. You'll ultimately need to speak with your accountant to determine the full extent of your business's write-offs. Don't be afraid to ask "dumb" questions or give too many details--your accountant is there to figure out the trickiest parts for you!
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