Many small business owners search for information on business tax deductions everywhere but IRS.gov. Why? Well, there’s something intimidating about asking the very organization whose wrath you seek to avoid how, exactly, to avoid said wrath. The language is also a bit stodgy (big surprise), and something about the white and gray website background and that terrifying logo (what is that, anyway? An ostrich sipping from a drinking fountain?) makes reading anything on the site just a chore.
Well, chore no more, brave Shoeboxers! What follows is the skinny on business tax deductions, right from the horse’s mouth, translated into Normal Human-ese.
“To be deductible, a business expense must be both ordinary and necessary.”
How does Uncle Sam determine what is ordinary and necessary? In true bureaucratic fashion, he looks at what everyone else is doing, and compares you to them. Let’s say you run a small web design company. Your typical business tax deductions might include the cost of design software, computers, office space, and seminars to keep you and your employees up to date on the latest design techniques.
Then let’s say, since you’re a forward-thinking, cool boss, you want to reward your employees with a trip to Cabo San Lucas. You may not consider this an “ordinary” expense – after all, none of your other website design boss buddies have taken their employees to Cabo. And it’s certainly not necessary – no one has to go on a luxury Mexican resort vacation.
And yet look what ‘ol Sam says next:
“An expense does not have to be indispensable to be considered necessary.”
That means that your vacation (or other non-ordinary deduction) can be considered necessary by the IRS, even if your business doesn’t absolutely need it to survive. And there are lots of ways you can spin this kind of trip as necessary for your business – you’re boosting company moral, creating camaraderie, encouraging teamwork and a family environment, and brainstorming the company’s future. Before you know it, trips like these could become “ordinary and indispensable” in your industry!
“You can usually capitalize the cost of a motor vehicle you use in your business. You can recover its cost through annual deductions for depreciation.”
Have a company vehicle? You may be under the impression that you’re going to simply write that sucker off and deduct your monthly car payments. Not so fast! Notice the distinction in the language – you may capitalize the cost of a vehicle – not deduct!
So what’s the difference? Pay attention, this part’s important: most IRS audits (and SMB headaches) have to do with business owners confusing capital and deductible expenses.
A deductible expense is a current expense – something you pay for regularly and use daily, like the electricity bill or the rent. These are the everyday, run-of-the-mill expenses that keep you in business.
A capital expense, on the other hand, is a long term investment in your business. These are things you purchase with the hopes of generating more income in the future. A company vehicle, for example, will be used on an ongoing, future basis to help your company make more money. Equipment that will help things run smoothly or renovations are other examples of capital expenses.
If you’re still having difficulty determining if an expense should be deducted or capitalized, ask yourself this: will you still be using this item (or enjoying these new, improved digs) in 12 months’ time?
If the answer is “yes,” this is a capitalized expense.
“So I can’t deduct anything I spent on the Doughnut-mobile?”
Actually, you can. You just have to deduct what you spend in a different way. Instead of deducting the amount you spent on the Doughnut-mobile at the end of the year, you’ll deduct the amount the Doughnut-mobile depreciates in value each year it’s in use. Now, there are limits to the amount you can deduct and how many years you can do it for (check out IRS Publication 463 for the deets).
Basically, you can still recover what you invested, but with capitalized expenses, it just takes a little longer
This is just the tip of the iceberg when it comes to business tax deductions. For more info (and if you’re brave), you can go to IRS.gov. Be sure and keep this page open in case you need a translation.
What has been your most surprising deduction?