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When it comes to business expenses, what can you actually deduct?

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Successful businesses know that one method they can use to offset otherwise unavoidable income taxes is to deduct their business expenses.  This basically reduces the amount of taxable net income.  The first question asked by most business owners is which expenses count as “business expenses”.  Well, the IRS says deductible business expenses are those which are “ordinary and necessary.”  For small business owners, this explanation can actually be more confusing than helpful.  

The IRS says business expenses are the “costs of carrying on a trade or business.”  Basically this means the cost of doing business.  In order for these expenses to be deductible, they must qualify as both ordinary and necessary.  Ordinary expenses are “common and accepted in [a given] industry” and necessary expenses are “helpful and appropriate for your trade or business.”

Some exceptions apply despite an expense appearing to be ordinary and necessary.  Identifying these exceptions is one benefit of working with a C.P.A., as the misidentification of a deduction on your tax return can result in the payment of penalties, late fees and the missing portion of the taxes you owe.

According to the U.S. Small Business Administration, home-based businesses are generating increased attention from the IRS, due in part to erroneous or fraudulent deductions appearing on tax returns.  While most of these discrepancies are certainly user-error, the fact remains that improperly applying deductions to can cost you much more than the savings you may enjoy.

Some commonly deductible expenses are vehicle expenses, employees’ salaries and wages, rent, interest, insurance and even taxes.  There are different deductions for employers and employees, sole proprietors, small business owners and corporations.

Before getting into some of the details of what exactly is deductible and how to do it, it is important to note that taxes are a major aspect of doing business.  The goal of applying deductions is to reduce the tax burden on businesses and affording them a fair opportunity to conduct business, not to eliminate the need to pay any taxes.  As such, it may be necessary for first-time business owners to temper their expectations when looking for deductible expenses. 

Interest paid or accrued on liabilities linked to your business are generally deductible.  If you meet certain requirements, which we can review, you may deduct interest expense.

Some costs, such as business start-up costs, assets and improvements must be capitalized, rather than deducted.  There are methods that allow you to deduct partial cost each year through the use of tools such as depreciation and amortization.  As the formation of a new business often requires the assistance of a C.P.A., this topic can be discussed in detail in order to maximize savings.

Meals and entertainment are another area that garners much attention. Perhaps this is due to the attention received by large corporations when they fund lavish events for their employees or clients, especially during the recent financial crisis.  It may be of some condolence to know that generally, you can only deduct 50% of these expenses because the government realizes that business will not take up 100% of your time on a hunting or fishing trip, sporting event, visit to a club, fancy restaurants or any number of decadent activities that may seem more like vacation than work.  The IRS tries to define these as places other than your main place of business where there are substantial distractions. 

Costs related to cars and other vehicles used for your business are generally deductible.  If you use a car for both personal and business needs, you may only deduct the costs associated with the business use of the vehicle.  Currently the IRS allows for .56¢ per mile, to be deducted as business expenses.  Costs may be used instead of the per mile allowance, and probably should if a vehicle is solely used for business, but this method makes it easy to determine how much to deduct when a vehicle’s use is split between personal and business use.  A common question related to the use of automobiles is “Can I deduct as a business expense the mileage I travel to and from my daily job?”  The answer, unfortunately, is no you cannot.  This time is considered personal time, regardless of the distance traveled to your place of work.  

The IRS allows sole proprietors to deduct the cost of hiring a C.P.A. to prepare your tax return.  With that in mind, please contact me with any questions you may have about deducting business expenses.  This is a large and complicated topic that warrants a deeper look.  I can be reached by email or by phone at (401) 383-6894.

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