Small Business Tax Deductions and Write-Offs

Operating a small business entails many expenses. Knowing which costs qualify as tax deductions or write-offs helps minimize taxable income and maximize after-tax profits. Business owners can leverage deductions for operating expenses, inventory, travel, meals, vehicles, healthcare and more with proper documentation.

Overview of Business Tax Deductions

The IRS allows small businesses to deduct reasonable expenses from revenue for the purpose of earning business income. This reduces taxable income at both federal and state levels. Major categories include:

Operating expenses – rent, utilities, supplies, software, contract services
Compensation – employee wages and owner distributions
Inventory – costs for merchandise sold during the year
Interest – business loan and credit card interest
Depreciation – vehicles, equipment, furnishings
Business travel – airfare, lodging, mileage, meals

Certain deductions like equipment purchases must be depreciated over time. Most operating expenses deduct immediately in the current year. Keep detailed records and receipts proving the business purpose.

Qualifying Operating Expenses

Ordinary expenses for running day-to-day business operations are fully deductible. Major examples include:

Rent, utilities, phone, internet for business facilities
Office supplies, postage, printing, publications
Software, subscriptions, tools, equipment
Accounting and legal fees
Insurance premiums
Advertising and marketing costs
Bank service charges and credit card fees
Licenses, registrations, permits

Also deduct percentages of household expenses for home-based businesses like mortgage interest, utilities, security systems, etc. Apportion based on the dedicated space.

Inventory Costs

For retailers, wholesalers, and manufacturers, the cost of goods sold (COGS) represents inventory expenses for producing or acquiring merchandise sold during the tax year. This directly reduces gross revenue.

Components of COGS may include:

Raw materials and components
Shipping freight costs
Direct labor involved in production
Packaging and label design
Damaged, expired or obsolete inventory

Keep detailed records around inventory including purchases, sales, shrinkage and periodic counts. FIFO, LIFO, and weighted averages determine valuation and flow assumptions.

Equipment and Vehicle Purchases

Tangible assets like machinery, computers, furniture, and vehicles require depreciation deductions spread over time versus immediate write-offs.

IRS tables specify depreciation periods, typically 3-7 years for most equipment. Take consistent deduction amounts each year based on original cost minus estimated salvage value. Include bonus depreciation when eligible.

For qualifying vehicles, deduct mileage driven for business purposes at the standard rate, 58 cents per mile in 2023. Include gas, insurance, repairs and other usage costs.

If financing equipment or vehicles, deduct respective interest payments as incurred, providing they remain 100% used for business.

Employee Payroll Costs

Reasonable salaries, wages, bonuses, and benefits paid to employees deduct from business income. This includes employer paid payroll taxes and contributions toward employee health insurance, retirement plans and disability benefits.

Reimbursements to employees for business expenses like mileage, travel meals, cell phone costs and supplies also deduct as incurred. Independent contractor payments report on 1099 forms instead.

Offering stock options or equity ownership plans complicates taxes but still allows deductions subject to limits, vesting schedules and strike prices. Consult a CPA on the details.

Health Insurance for Owners

Health insurance premiums paid by the business for employees deduct as standard operating costs. As a small business owner, you can deduct premiums on policies that cover yourself, a partner, or family members.

However, rules exist regarding reasonableness of compensation and controlling ownership stakes. Consult a tax professional to ensure your specific situation qualifies.

With proper setup, you may deduct 100% of health insurance costs for yourself, spouse and dependents as a business owner. Include premiums, co-pays, deductibles and qualified medical expenses.

Retirement Plan Contributions

Businesses gain significant deductions for contributions made toward qualified retirement plans up to set limits. Options include 401(k) plans, SEP IRAs, SIMPLE IRAs, and individual 401(k) plans for owner-only companies.

For example, businesses may deduct up to 25% of compensation per eligible employee, capped at $66,000 each for 2023. This reduces FICA tax obligations as well. Additional options exist for older employees to make larger catch-up contributions.

As a small business owner, maximize your own retirement plan contributions to reduce both business and personal income tax liabilities. Work with a financial advisor to select optimal plans.

Business Travel, Meals and Entertainment

Travel costs for bona fide business purposes allow deductions for transportation, lodging, 50% of meals, and limited entertainment. Keep detailed logs documenting dates, locations, purposes, attendees, and expenses.

Document business versus personal time during trips. Hold meetings and events at appropriate venues conducive to business dealings, not tourist locations. Restrict durations to reasonable periods.

Entertainment deductions face heavy scrutiny. Dedicate time to business discussions before events. Avoid lavish expenses. Restrict alcohol. Limit attendee guest costs.

Home Office Deduction

Home-based businesses qualify to deduct home office expenses provided the space is used regularly and exclusively for business. Calculate home office deductions using either:

Actual expenses for the dedicated area like rent, utilities, maintenance.
Simplified option taking $5 per foot up to 300 square feet.

Take care to properly calculate allowable business use percentages. Mixed space that is not fully exclusive may only qualify for partial deductions.

Startup and Organization Costs

Businesses may deduct up to $5,000 in startup costs incurred in the year of founding. Remaining excess costs amortize over 15 years. Allowable expenses include analysis, professional services, travel, advertisements, wages and initial supplies.

Similarly, deduct up to $5,000 in business incorporation or organization costs like legal and professional fees. Remaining excess costs deduct over 180 months.

Business Credits

Beyond deductions that reduce taxable income, special business tax credits directly reduce taxes owed. Examples include:

Research and development credit
Employer wage credit
Energy efficient commercial buildings credit
Disabled employee credit
Credit for employer child care payments

Discuss credits unique to your business with a tax professional. Certain credits like R&D phase out based on revenue and staff size.

Managing Self-Employment Taxes

Sole proprietors and independent contractors pay self-employment taxes on net business income after deductions. For 2023, this entails 15.3% for Social Security and Medicare up to $160,200 of earnings.

One tax strategy is forming an S corporation or limited liability company taxed as an S corp. This allows paying yourself a reasonable salary on which you pay payroll taxes, then taking remaining net income as distributions not subject to self-employment taxes.

Closing Thoughts

Properly tracking and claiming available business deductions reduces taxable income and owed taxes. Consult closely with accounting and tax professionals to maximize write-offs while maintaining proper documentation. Understand how deductions, credits and retirement plan contributions all integrate to lower business tax liabilities. Use available tax savings to reinvest and grow your business operations and personal wealth.