A tax deduction is defined as an amount deducted from income before it is subject to tax. This includes expenses incurred to produce income and costs to operate the business.
These are often subject to very strict conditions, specific definitions and limitations. The vast amount of details that tackle how tax deductions work vary per country, but in this post we will focus on the US.
Efficient Tax planning is a critical activity for any start up business. Paying the correct amount ensures you avoid any possible fines. It’s also not a good idea to over pay because even if you do get a refund, the money would’ve been unusable to you in the meantime.
Conditions for a business expense to be deductible:
An expense should be both ordinary and necessary.
- It must be ordinary. It should be something that is common and accepted in the trade or business. Something that you’d typically need to run your business.
- It must be necessary. This means the expense is helpful and appropriate for your trade or business.
A good example of an “ordinary and necessary” expense is promotional material used for your business. Another good example is the use of your vehicle for business purposes. Bear in mind that keeping an accurate record of your expenses is critical to ensuring accuracy on your tax statement.
To determine if an expense is deductible, check if they meet the following criteria:
- If the expense is for something you need to run your business, then you can use it as a deduction. For example; the monthly expense for your DSL subscription can be considered deductible as long as it’s only used at your home office. However, once you share it wirelessly in your home then it’s no longer an acceptable deduction.
- If the expense can be considered part of “capital expenses” or “cost of goods sold” then they cannot be deducted under “ordinary and necessary” business expense.
You also have to remember that there are still limits even if a deduction is valid.
Here’s a short list of possible deductions:
- Professional Bookkeeping & Accounting Expenses
- Marketing Expenses
- Reference Materials, Hardware & Software
- Use of Car or Truck for Business purposes
- Insurance Expense
- Interest on Business Debts
- Legal and Professional Fees
- Office Supplies and Materials
- Tax Preparation Expenses
- Business, Travel and Entertainment Expenses
- Home use Deduction
Having strict and accurate records backed by documentation is a must. Don’t risk fines and other penalties by filing for deductions you can’t support. Deductions for home based businesses are heavily scrutinized. If you have some doubts about your tax preparations please consult a licensed expert.
Knowing what deductions you’re entitled to can go a long way to helping your business avoid unnecessary fines and over payment. If you need more detailed information, please talk to a registered CPA or inquire with the IRS site directly. The site will try to give you some pointers about deductions, but it’s better to discuss your questions with licensed tax experts.