You have to spend money in order to make money. Or so the saying goes. Fortunately, the small business owner can recoup much of what is spent on the debit side through tax write-offs and deductions.
The IRS defines a business expense as any cost associated with carrying on a trade or business. If the business is operated to make a profit, these expenses are generally deductible. In order to be deductible, a business expense must be considered both ordinary and necessary.
An expense is considered ‘ordinary’ if it is familiar to and accepted for general use in your trade or business. An expense can also be ‘necessary’ if it’s judged to be helpful or required to carry on your business activities.
The IRS is flexible in practice when it comes to these two terms. Most regular expenses for small businesses are deemed as ordinary, necessary or both. An example of an ordinary expense would be mileage costs for a realtor; a necessary expense would be the annual license fee.
Capital and Personal Expenses
Before you can start hacking through your expenses, you first need to exclude any expense that is a capital expense or a personal expense. Neither is fully deductible from gross proceeds of a business.
Capital expenditures are associated with the start-up of the business. Since these expenses are incurred prior to the establishment of the actual business, they cannot be deducted as a business expense. However, you may be able to amortize your start-up costs over a 60-month period.
Generally, you cannot deduct personal expenses either. At times however, an expense may be used for both business and personal purposes. If so, apportion the total cost between the business and personal usage and deduct only the expenses that relate to the business.
Business Use of the Home
Many businesses are operated out of the home, or a portion of the home is used as an office or work area to coordinate the business. There are two basic requirements in order for your home or a portion of it to qualify. It must be used regularly and exclusively for business, and it a must be your principal location from which the business operates.
If your home qualifies, you may deduct a portion of your mortgage interest, insurance, utilities, repairs and depreciation. IRS Publication 587, Business Use of Your Home, will assist you in determining this.
Unless your business is exclusively home-based, there are likely significant expenses associated with your vehicle. The trick here is being able to differentiate between personal and business usage. The IRS allows a deduction based on the standard mileage rate or actual expenses. The standard mileage rate for 2010 is 50 cents on every mile.
If you choose to deduct actual expenses, there are many deductions to consider when it comes to transportation. Parking fees, the cost for advertisement on a vehicle, lease fees, gas and oil, tolls, insurance, garage rent, registration and license fees – all can be deducted if they are connected to the business.
Publication 463 discusses transportation fees along with expenses for entertainment, gifts to clients and other travel fees.
Other small business deductions that should not be overlooked include:
• Employee pay and retirement plans
• Interest on funds borrowed to operate the business
• Federal, state, local and foreign taxes
• Insurance for yourself, your employees or your business assets
• Business bad debts
See IRS Publication 535, Business Expenses, for more information on deductible business expenses.