Anthony Brister, Tax Attorney & Founder of The Brister Law Firm, PLLC
I am sure you have probably been curious about what is a write off or what is a deduction? Who can write stuff off and what does it really mean?
What is a Tax Deduction? Understanding Tax Deductions for Small Business Owners
Tax deductions are one of the most commonly misunderstood aspects of running a small business. If you're new to business ownership or have been in business for years without a clear understanding of tax deductions, this guide is for you.
In this article, I’ll break down what a tax deduction is, how it works, and provide you with common examples and strategies to maximize your tax savings. By the end, you’ll understand how to use tax deductions effectively and why working with a tax professional can improve your financial success.
What is a Tax Deduction?
A tax deduction is an expense that you can subtract from your total income, reducing the amount of income that is subject to taxation. Think of a tax deduction as a discount on your taxable income. Instead of receiving a dollar-for-dollar refund, a deduction reduces the portion of your income that the IRS considers taxable. I REPEAT THIS IS NOT A DOLLAR FOR DOLLAR TAX SAVINGS!
For example, if your business earns $100,000 in revenue and you have $20,000 in eligible deductions, you only pay taxes on $80,000. This can make a significant difference in the amount of tax you owe, especially if you’re in a higher tax bracket. In this example at a 30% tax bracket, you are saving $6,000 on taxes on this $20,000 of deductions.
Why End-of-Year Tax Planning is Important
As the year approaches, end-of-year tax planning is so important for small business owners. This is the time to review your financials, identify potential deductions, and make strategic moves to lower your tax liability. Proper planning can help you take advantage of deductions you may have overlooked throughout the year.
At Brister Law Firm, we offer comprehensive end-of-year tax planning meetings to help you understand your deductions, assess your business structure, and ensure compliance. Schedule a free discovery call to see how we can assist you in maximizing your tax savings.
Breaking Down How Tax Deductions Work Again: Bobby
Let’s go through a simple example to clarify how tax deductions work. Imagine Bobby is a small business owner who made $100,000 this year and falls into a 20% tax bracket:
Income: $100,000
Tax Rate: 20%
Without Deductions: Bobby would owe $20,000 in taxes.
Now, if Bobby has $20,000 worth of business deductions:
Adjusted Income: $100,000 - $20,000 (deductions) = $80,000
Tax Owed: 20% of $80,000 = $16,000
In this case, Bobby saves $4,000 in taxes because of his $20,000 in deductions. It’s important to note that the deduction reduces taxable income, not necessarily the amount paid out of pocket. It’s more like a discount based on your tax rate rather than a direct refund.
Common Tax Deductions for Small Business Owners
Knowing which expenses qualify as tax deductions is key to reducing your tax burden. The IRS requires that deductible expenses be both "ordinary" and "necessary" for your business.
Here are some of the most common deductions:
1. Home Office Deduction
If you use a portion of your home exclusively for business purposes, you may qualify for a home office deduction. This can include expenses like rent, mortgage interest, utilities, and repairs. The space must be used regularly and exclusively for business activities.
2. Business Use of a Vehicle
You can deduct expenses related to the business use of your vehicle, either using the standard mileage rate or actual expenses (like gas, repairs, and insurance). Keep detailed records of your mileage and business-related trips to substantiate these deductions.
3. Office Supplies and Equipment
Items like pens, paper, computers, and other office supplies used for business purposes are deductible. For larger purchases, such as computers or machinery, you may need to depreciate the expense over several years rather than taking a full deduction in the year of purchase.
4. Marketing and Advertising Costs
Advertising and marketing expenses, including website costs, social media ads, and promotional materials, are fully deductible. This helps offset the cost of growing your business and reaching new customers.
5. Legal and Professional Fees
Fees paid to accountants, attorneys, and other professionals for business services are deductible. This includes costs associated with tax preparation, legal consultations, and business planning services.
Tracking Expenses: The Key to Maximizing Deductions
To take full advantage of tax deductions, you need to keep accurate and detailed records of your expenses. Using tools like QuickBooks or Excel can help you track income and expenses throughout the year, making it easier to categorize and substantiate deductions when it’s time to file your taxes.
Open a Separate Business Bank Account: Keep your personal and business expenses separate to avoid confusion and make tracking easier.
Use Accounting Software: QuickBooks allows you to import bank transactions, categorize expenses, and generate reports quickly and accurately. This makes it easier for you and your tax professional to identify potential deductions.
Depreciation and Amortization of Large Purchases
Not all expenses can be deducted in full during the year they are incurred. For large purchases like real estate, machinery, or high-cost electronics, you may need to spread out the deduction over several years through depreciation or amortization.
Depreciation: Typically used for tangible assets like vehicles, buildings, and equipment.
Amortization: Used for intangible assets like patents or goodwill.
These methods allow you to spread the tax benefit of a large expense over its useful life, helping you manage your taxable income in a more balanced way.
Top Tax Deductions for Small Business Owners
Here’s a list of common deductions you should consider if you own a small business:
Cell Phone and Internet: If you use your phone or Internet for business purposes, you can deduct a portion of these expenses.
Travel Expenses: Business-related travel costs, including airfare, hotel stays, and meals, can be deducted if they are necessary for business activities.
Meals and Entertainment: Currently, 50% of business-related meal expenses can be deducted. Keep detailed records of the purpose of the meeting and who was present.
Education and Training: Expenses for professional development, such as courses, workshops, and seminars, are deductible if they help you improve skills related to your business.
Conclusion: The Importance of Working with a Tax Professional
Tax deductions can save you a significant amount of money, but they require careful planning and documentation. Every business is unique, and what qualifies as a deduction for one company may not apply to another. Working with a tax professional can help you navigate the complexities of tax laws, avoid costly mistakes, and ensure you’re maximizing your deductions.
At Brister Law Firm, we specialize in helping small business owners like you save money and grow your wealth through effective tax planning. Schedule a free discovery call today and ask about our comprehensive end-of-year tax planning consultations.
FAQs
What is a tax deduction?
A tax deduction is an expense that reduces your taxable income, lowering the amount of tax you owe.
Can I deduct my home office expenses?
Yes, if you use a portion of your home exclusively for business purposes, you may qualify for a home office deduction.
How do I track business expenses?
Using accounting software like QuickBooks or keeping a detailed Excel ledger can help you track and categorize your business expenses.
What expenses can I depreciate?
Large purchases like real estate, machinery, and equipment often need to be depreciated over time rather than deducted all at once.
Why should I work with a tax professional?
A tax professional can help you understand complex tax laws, identify eligible deductions, and ensure you’re in compliance with IRS regulations.
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