Small Business Tax Deductions and Credits
Tax time is approaching fast. Unless your small business is structured as a C corporation, you will likely owe self-employment (SE) tax on your net profits, along with your usual income taxes.
Fortunately, there are several deductions and credits that can reduce the overall tax burden for self-employed individuals, partnerships, and LLCs.
Whether you are planning to hire a professional or do your taxes yourself, you should be aware of a few of the tax benefits available to small businesses.
The standard deduction, which lets you deduct a fixed amount from your taxable income, is a simple way to reduce your total tax due.
Because standard deduction amounts have increased significantly in recent years, many taxpayers now choose to claim this deduction rather than itemizing their personal expenses—such as medical and dental costs, state and local taxes, mortgage and home equity interest, and charitable contributions.
On the other hand, you might find that itemizing your Schedule A deduction results in more significant savings for you and your business. In this case, filling out the paperwork may be worth the extra effort—just make sure you have the necessary documents to back up your claims (in case you’re audited).
The standard deduction amounts for 2020 are as follows:
- $12,400 for single taxpayers or married couples filing separate tax returns
- $18,650 for individuals filing as head of household
- $24,800 for married couples filing jointly (or surviving spouses)
Note that certain factors disqualify taxpayers from taking the standard deduction. If you file separately with a spouse who is itemizing their deductions, if your business is a partnership, or if you haven’t been a citizen or legal resident of the U.S. for the full tax year, you won’t be eligible.
Additionally, if you do qualify for the standard deduction, some factors may limit your deduction amount (such as being claimed as a dependent) or increase it (such as being blind or over the age of 65). This IRS tool can help you quickly determine what your total standard deduction will be.
Qualified Business Income Deduction
Whether you are planning to take the standard deduction or itemize, you will still be eligible to claim the Qualified Business Income Deduction (also called Section 199A) for your pass-through business entity—provided you meet all the criteria.
Section 199A allows a deduction of up to 20 percent on net income for sole proprietors, partnerships, LLCs and S-Corps—basically any business type that operates as a pass-through entity (where profits and losses “pass through” to the owner’s tax return).
However, keep in mind that your taxable income must be at or below a certain threshold to receive the full 20 percent. For those over the threshold, various limitations apply, which reduce this percentage.
This year, limitations on Section 199A will apply to taxpayers with income above $163,300 for single and head of household returns, $326,600 for joint filers, and $163,300 for married filing separate returns.
Note: If your taxable income places you just slightly over the threshold, you might consider asking your tax professional whether tax planning can help you to claim the full 20 percent deduction next year. Contributing to a 401k retirement account is one sensible way to reduce your gross income; making tax-deductible contributions to charities is another.
Business Interest Deduction
The interest on your business loans (if you have any) may be deductible—and the CARES Act has potentially made it easier for small business owners to benefit from this allowance.
Until recently, the business interest deduction had to be less than 30 percent of the business owner’s adjusted taxable income. With the CARES Act, this limit has increased to 50 percent for the 2019 and 2020 tax years. This increase is applicable to all business types other than partnerships.
If you think your business could benefit from the 50 percent business interest deduction, you (or your tax professional) can apply by attaching Form 8890, Limitation on Business Interest Expense, to your tax return.
Be aware, though, that electing to use the 50 percent business interest deduction rate may be more advantageous to some businesses than others. You will want to discuss the pros and cons with your accountant or tax preparer.
Sick and Family Leave Credit
Eligible self-employed individuals and small business owners may be able to claim Covid-19 sick and family leave tax credits using IRS Form 7202.
If you were unable to work for a period of time in 2020 due to self-quarantine, Covid-19 symptoms, having to care for someone with Covid-19, or lack of childcare due to school or daycare closures, these refundable tax credits could help to reduce your federal income tax bill.
For leave taken in 2020—between April 1 and December 31—you will claim your credits on your 2020 Form 1040. Credits for leave taken in 2021 (between January 1 and March 31) can be claimed when you file your 2021 taxes.
Deductible Operating Expenses
The IRS’s list of tax-deductible business expenses is long—these are just a few. You’ll want to do your research and consult your tax professional to ensure you are taking advantage of every deduction available to you.
Self-employed individuals who work from home (in a workspace that is regularly and exclusively used for business purposes) are eligible to deduct the costs of maintaining this space.
You can either use the simplified option—taking $5 per square foot up to 300 feet—or you can calculate it as a percentage of your home’s total square footage, itemizing all costs associated with the space.
IRS Form 8829 can help you to determine which home office expenses to deduct.
A majority of small businesses now have websites, social media campaigns, and SEO (Search Engine Optimization) strategies to increase their visibility online. The good news is these marketing expenditures—and others—are tax-deductible, as long as they are reasonable and directly related to your business.
Sole proprietors and single-member LLCs will need to record their advertising expenses on Schedule C, while partnerships and multiple-member LLCs should use Form 1065: Partnership Income Tax Return.
Business Use of Your Vehicle
If you use your car for business purposes, you can deduct the associated expenses (fuel, car maintenance, insurance) on your tax return. Just make sure to divide your expenses based on mileage if you regularly use your vehicle for both business and personal purposes. The IRS provides a list of standard mileage rates to help you calculate your deductible costs of operating your vehicle for your business.
Navigating your small business taxes might not be easy, but learning about the benefits available to your business can help to soften the blow when your tax bill comes due. For more information, visit the IRS Self-Employed Individuals Tax Center or reach out to a SCORE mentor.
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Funded, in part, through a Cooperative Agreement with the U.S. Small Business Administration. All opinions, and/or recommendations expressed herein are those of the author(s) and do not necessarily reflect the views of the SBA.