Tax time is just around the corner for calendar-year tax filers, and this means we have only days left to take steps to maximize deductions for the 2017 tax year! The tax code is complicated—as a small business owner, you might have missed little-known tax deductions that you qualified for last year!
In this article, we’ll take a look at three little-known tax deductions that might save you money this tax-filing season.
Small businesses are allowed to deduct certain expenses that individual filers typically are not if they can prove that the expenses are necessary to running their business.
In order to deduct expenses in your business, the expense must be both ordinary and necessary. Per the IRS, “an ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business, and an expense does not have to be indispensable to be considered necessary.”
IRS rules say that you cannot deduct personal, living, or family expenses such as food, rent, mortgage payments, or expenses you incur to keep up your personal residence. But if you have an expense that is used partly for business and partly for personal use, you can deduct the portion that is attributed to your business.
For example, if you take out a loan and use part of the loan for business and part of the loan to buy your kids a swing set, you can deduct the portion of the interest expense that is incurred on the money used in your business until you pay off the loan.
It is also important to understand that the way you account and pay for expenses could determine whether or not you are eligible for a deduction.
A best practice is to have separate bank and credit card accounts for your personal and business expenses. I always discourage my clients from co-mingling personal and business funds because it can affect whether the IRS will allow the deduction under audit and because it can be harder to prove that an expense is business related when it has been paid from personal funds.
Now that we know what is considered a business expense and what affects its deductibility, let’s take a look at some little-known tax deductions you may be able to take this year to lower your tax bill!
There has been a lot of confusion about whether business owners can deduct costs to maintain their personal residence.
If you use a part of your home to regularly conduct business or to store inventory for your business, you might be able to deduct the costs to maintain your home including rent, mortgage interest, property taxes, utilities, and repairs and maintenance (such as a security system or lawn care). In order to qualify for this deduction, you must use the area in your home exclusively for business.
This means that you can’t have a room in your home that you use personally part of the time but conduct business there occasionally. But if you have an area in a room that is used exclusively for business (such as a desk), you can use that part of the room that is used exclusively for business to take a deduction against your business income.
The deduction is typically figured by dividing the square footage of area used for business by the total square footage of your home. Then you multiply that percentage times the total of the expenses incurred. If you are an employee who uses part of your home for business or you store inventory in part of your home, other rules may apply. You can learn more about business use of your home in IRS Publication 587.
If you use your home or other property for business events, such as employee retreats or to host client or customer events, your business can “rent” the property from yourself as long as the property is only rented for 14 days or less for the entire year (including rental to other parties). The rent would be deductible on your business return, but you would not have to report the income on your personal return. Just make sure you have a proper contract in place and follow the specific guidelines outlined by the IRS.
The Domestic Production Activities Deduction (DPAD) went into effect in 2005 and is intended to encourage businesses to produce goods in the U.S. rather than overseas. This little-known tax deduction can apply to almost any business, large or small, that manufactures, grows, extracts, produces, develops, or improves goods primarily in the United States. Examples of activities that qualify are construction, engineering and architectural services related to U.S. construction, film-making, software and video game developers, and farming and agricultural activities.
The DPAD can be a great deduction for qualifying businesses, but it has some limitations. The deduction cannot exceed adjusted gross income for sole proprietors, partnerships, S-corporations, or LLCs, or taxable income for C-corporations. And it cannot exceed 50% of the amount paid in W-2 wages. In addition, your business qualifies only if it has employees.
To learn more about the DPAD and to find out if your business qualifies, check out the instructions on the IRS website or ask your tax professional.
If your business is a restaurant and has employees who receive tips, you might be able to take a credit for the social security and Medicare taxes you pay on your employees’ tip income.
This credit was introduced to encourage restaurant employers to accurately report tip income for their employees. Restaurant employers are responsible for making sure that their non-exempt employees earn at least the federal minimum wage for all hours worked.
To claim this credit, your employees must be paid at least minimum wage including tips they earn. The credit equals the employer’s portion of the FICA tax (currently 7.65%) multiplied by the tips in excess of the federal minimum wage. The credit is not refundable, but if it exceeds your regular income tax for a year, the excess can be carried back or forward to be applied to other tax years.
To learn more about the FICA credit for tipped employees, check out this article from the IRS website.
These three little-known tax deductions could help to lower the taxes you pay this coming tax season. As always, make sure you do your research. Or better yet, hire a qualified tax professional to help you save money on your taxes and file an accurate return!