An important strategy for small business owners is identifying and using any suitable tax write-offs. The main advantage to write-offs is legally reducing your company’s and, if you are self-employed, your personal tax liability.

What Tax Write-offs Do Smart Small Business Owners Take?

Small businesses can use a number of tax write-offs, typically referred to as deductions and credits. 

Before we discuss the difference between a deduction and a credit, let’s clarify two things:

  1. Many tax “loopholes” are complex and designed for large, well-established businesses (because they require the expenditure of large amounts of money in the ordinary course of business to qualify or otherwise take advantage of them). Think of companies like Microsoft or Ford.
  2. Spending a dollar to save 28 cents (or thereabouts, depending on your applicable tax rate) is not good business or tax planning. 

The Internal Revenue Code says you can write off all ordinary and necessary expenses of carrying on a trade or business in the year you incur the expenses. Does that mean you should start spending money to save taxes? Definitely not!

Structure your business and its operations to be profitable and fulfill the purpose for which you started the business – whatever that might be. 

As a bonus, you might also get a tax benefit through a credit against your tax, or, much more likely, you can deduct expenditures your business makes in the normal course of its affairs.

What Is a Tax Deduction?

A tax deduction is any ordinary and necessary business expense incurred while operating a trade or business. Subtract a tax deduction from income to determine taxable income. 

Here is an example:

Sales                 $100,000

Expenses   $30,000 (deducted)

Taxable Income $70,000

This business would pay taxes on $70,000 for the year. The more expenses you have, the less tax you will pay. However, that doesn’t mean increasing expenses to save money on taxes is wise.

What Expenses Can Be Written Off?

Here are some typical expenses that you can write off:

  • Advertising
  • Employee salaries and wages (and the associated employer share of payroll taxes)
  • Insurance
  • Interest (on business loans)
  • Legal and professional costs
  • Materials or other direct costs of generating sales
  • Office equipment and expenses
  • Rent
  • Repairs and maintenance
  • Supplies
  • Telephone 
  • Travel (for business purposes)
  • Utilities 

Some expenses are limited in their deductibility, such as meals—for which only a 50% deduction is allowed—gifts, and certain dues. Some expenses, such as business use of a car or an office in the home, require special documentation. Finally, buildings, equipment, and machinery are not all written off in one year. You write off the expense over the years you use the item for the business (known as depreciation).

How to Record Business Expenses

The IRS allows a business to deduct ordinary and necessary expenses. But what are the requirements?

You must document all expenses to ensure deductibility, or the IRS will not allow them (and may trigger an audit). Any business deduction you claim must have a bill or receipt supporting the transaction showing the amount, date, payee, and business purpose.  

Some deductions, such as depreciation, require a supporting document at the time of purchase and a record kept (by business owners or an accountant) of the amount of depreciation taken each year.

Can I Deduct My Car?

You can use a car for business purposes and take an automobile deduction, but you must keep detailed records regardless of whether the vehicle is used 100% for business. 

The IRS requires you to write mileage records in a timely manner. A mileage log must show the date, purpose, beginning mileage, and ending mileage for all business purposes. 

Keeping track is especially important if you use the vehicle for business and personal purposes. You cannot log personal and commuting usage.

You can deduct an automobile based on actual expenses – gas, oil, repairs, insurance, depreciation, taxes – or the miles driven for business purposes multiplied by a rate determined by the IRS. A business is allowed one or the other, but not both, in a given year. 

With proper record keeping, an accountant can determine the best deduction. The key is to keep detailed records in case an audit occurs. Without them, an audit will most likely disallow a vehicle deduction. Fortunately, apps are available that can assist in keeping mileage records.

What Is a Tax Credit?

A tax credit is a dollar-for-dollar reduction in the amount of tax a business owes. 

Sales $100,000

Expenses             – $30,000

Taxable Income         $70,000

Tax Rate (20%)              x 0.20

Taxes Owed               $14,000

Tax Credit               – $1,000

Total Owed                 $13,000

Above is a simplified example. Tax credits are generally limited in reducing tax liability and cannot produce a refund

In many cases, the actual amount of the credit may not be fully used in a given tax year, and any unused portion can then be carried back to the previous year or carried forward for 20 years.

Tax credits are much more complicated than tax deductions. While there are a number of credits available, virtually all of them are obscure, very specialized in nature, have rigorous requirements, and are very costly to implement to generate the credit. 

Tax credits are generally lumped together and called the General Business Credit and reported on Form 3800, which is attached to the business tax return. Most credits target industries and activities in the public interest (as defined by Congress).

What Tax Credits Are Available?

A few credits might make sense for a small business. 

For example, the Work Opportunity Credit provides a credit to businesses that hire employees from targeted groups with a high unemployment rate or other special employment needs. 

There are also credits for businesses that start pension plans, engage in research and development activities, provide disabled access, or provide on-site childcare facilities and services. Even so, the requirements for all of these are lengthy.

Tax Deductions for Small Businesses

You can deduct all ordinary and necessary business expenses for tax purposes, provided they have proper documentation. Tax credits may be available but are complicated, costly, and generally obscure. 

No business should run strictly to get a tax deduction or generate a tax credit. Consulting with a competent and qualified professional, such as a Certified Public Accountant or Enrolled Agent, can help with these matters. All these things support the smart small business owner in their primary endeavor: to make a profit.