Small Business Expenses and Tax Deductions
The following article discusses small business expenses in addition to the two tax deductions, business expense deductions and capital expense deductions.
Guidance for the Self-Employed and Sole Proprietors
There are two basic tax concepts new business owners need to add to their vocabulary: business expenses and capital expenses.
Business expenses are the cost of conducting a trade or business. These expenses are common costs of doing business, and are usually tax deductible if your business is for-profit. For example, costs of renting a storefront, business travel and paying employees are all deductible business expenses.
Capital expenses are the costs of purchasing specific assets, such as property or equipment that usually have a life of one year or more and increase the quality and quantity of products and services you can provide. For example, if you own a landscaping business and you purchase mowers and excavating equipment, these costs are capital expenses and do not qualify as deductible business expenses. However, you can recover the money you spent on capital expenses through depreciation, amortization, or depletion. These recovery methods allow you to deduct part of your cost each year so that you are able to recover your capital expenses over time.
Figuring out whether a purchase is a business expense or a capital expense is not always clear cut. Consider taking advantage of free tax training opportunities offered by the U.S. Internal Revenue Service (IRS). If you have hired an accountant, you should also seek his or her advice regarding tax deductions.
The following information provides a brief overview of expenses that qualify as tax deductions, with links to resources that provide clear guidance on deducting and capitalizing your expenses.
Deducting Business Expenses
To be deductible, a business expense must be both “ordinary” and “necessary.” An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate for your business.
Personal Versus Business Expenses
Generally, you cannot deduct personal, living or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal portions. You can deduct the business portion. For example, if you borrow money and use 70 percent of it for business and the other 30 percent for a family vacation, you can deduct 70 percent of the interest as a business expense. The remaining 30 percent is personal interest and is not deductible.
Home Office Deduction
Are you a home-based business? If you are using part of your home for business, you may be able to deduct some expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. If you are a homeowner or renter, the home office deduction is available and applies to all types of homes, from apartments to mobile homes. There are two basic requirements for your home to qualify as a deduction:
Regular and Exclusive Use. You must regularly use part of your home exclusively for conducting business. For example, if you use an extra bedroom to run your online business, you can take a home office deduction for the extra bedroom.
Principal Place of Your Business. You must show that you use your home as your principal place of business. If you conduct business at a location outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for a home office deduction. For example, if you have in-person meetings with patients, clients or customers in your home in the normal course of your business, even though you also carry on business at another location, you can deduct your expenses for the part of your home used exclusively and regularly for business. You can deduct expenses for a separate free-standing structure, such as a studio, garage or barn, if you use it exclusively and regularly for your business. The structure does not have to be your principal place of business or the only place where you meet patients, clients or customers.
Generally, deductions for a home office are based on the percentage of your home devoted to business use. So, if you use a whole room or part of a room for conducting your business, you need to figure out the percentage of your home devoted to your business activities.
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Visit the IRS page on Home Office Deductions for a full explanation of tax deductions for your home office.
Travel, Meals, Entertainment and Gifts
As you know, most companies expense items such as travel costs associated with business, in addition to meals, entertainment and gifts. However, there are rules to follow for these deductions.
Generally, you can deduct all of your travel expenses if your trip was entirely business-related. These expenses include the travel costs of getting to and from your business destination and any business-related expenses at your business destination, including tips, cab fare, and other “life on the road” expenses such as dry cleaning. Meals are the only exception. You can deduct only 50 percent of your meals while traveling.
If your business trip includes personal side trips or extended stays for a personal vacation, you can only deduct travel expenses used for business-related activities. For example, suppose you live in Atlanta, and then went on a five day business trip to New York. You spent three days in business meetings, and two days sight-seeing and visiting friends. You can only deduct the costs of the three days you spent on business activities.
If you take your family on vacation to Hawaii, and conduct business there, you can deduct any expenses that are directly related to your business. However, you may not deduct the entire cost of the trip as a business expense.
For a full explanation of tax deductions for business travel, entertainment and gifts refer to
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Business Use of Your Car
If you use your car in your business, you can deduct car expenses. If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. Refer to the following resources for more information about using your vehicle for business:
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The Car Expenses Section in IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses.
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For a list of current and prior year mileage rates see the Standard Mileage Rates