Overlooked Tax Deductions for Small Businesses - Part 1

Starting and operating a small business isn't always a walk in the park, and small businesses can be met with a host of challenges. Therefore, it's not surprising that many small businesses fail to become viably profitable within their first few years and end up closing their doors. This is why it is important for small businesses to take advantage of all of the tax deductions available to them in order to decrease their tax burden and save money. However, many tax deductions that small businesses can use are frequently overlooked.

Small businesses and independent contractors can calculate the costs of business expenses and deduct this from their overall taxable income. Many of these business expenses are obvious, such as office space or warehouse rent, workers' wages, insurance, the overhead cost of initial inventory, equipment used to run the business, etc. Some expenses are not always considered, though, which can save small enterprises additional money. Some of these deductions will require more diligent record-keeping but can be worth it in the long run as a significant amount of money can be saved. Here we will look at some of the most common tax deductions that many small businesses overlook.

The following is a list of some of the most overlooked or unknown tax deductions that small businesses can take advantage of:

199A Small Business Tax Deduction

The 2017 tax reform act — the Tax Cuts and Jobs Act (TCJA) — included many notable changes in many areas of taxation, but one particular piece had a significant impact on small businesses. This legislation allowed qualifying small businesses to deduct 20% of their taxable income right off the bat. This means you could deduct 20% from your overall gross income before taxes are calculated. This deduction applies to sole proprietors, LLCs. S-corps, partnerships, and self-employed individuals. It can also be used regardless of whether or not the taxpayers are utilizing the standard deduction or itemized deductions.

There are income brackets that affect this deduction, however. As of 2022, the full deduction is allowed to small businesses with a taxable income no greater than $170,050 for single filers and $340,100 for joint filers. This deduction was put into place in 2018 and is scheduled to last until the end of 2025 unless extended by congress. So now is a better time than ever to take this large deduction if your business qualifies.

Start-Up Costs

Start-up costs for a small business can be expensive and can add up quickly. While technically, start-up costs are not considered money that is expended by the company but as money that is invested into the business, there are ways that certain start-up costs can be deducted. These initial investments into a business are also called capital expenditures. There are two types of costs that are deductible. These are Business Start-Up Costs and Organizational Costs.

The first category, Business Start-Up Costs, applies to costs incurred while creating an active trade or business. Business Start-Up Costs can also include any costs related to the preemptive investigation of the creation or acquisition of a trade or business. Organizational Costs are also known as incorporation costs and can consist of the costs incurred while forming an LLC, Partnership, or Corporation. These include filing fees, legal fees, accounting fees, etc.

How much of your Business Start-up Costs can you deduct with these things in mind? For example, if you spend no more than $50,000 on start-up costs, you can deduct up to $5,000 of these costs within your first year of operation. The same ratio and time frame also apply to Organizational Costs. The remaining amount of your start-up cost ($50,000) must be amortized over 180 months or 15 years, i.e. gradually deducted over time.

If you spend more than $50,000 on Business Startup Costs and Organizational Costs, your first year's deduction will be decreased by $1 for each dollar that is spent over $50,000; this remaining amount must be amortized over the 180 months or 15-year period. For example, if you spend $51,000 on start-up costs, you can only deduct $4,000 in your first year of business. The remaining $1,000 and the other $50,000 can be amortized over 180 months or a 15-year period. Businesses that spend over $55,000 on their start-up costs will not be eligible to deduct any of this in their first year of business and must amortize the full amount. To summarize, if you spend under or over $50,000 on start-up costs, after your first year's eligible deduction amount, you can deduct the entirety of your initial start-up costs over 15 years!

Deducting start-up costs is often overlooked by small businesses as they are eager to get started on their path toward profitability. However, these deductions, including the first-year deductions, can result in significant savings that can help your small business survive in the short term, which can help it succeed in the long term. So, this is a vital deduction to take into account, and diligently tracking all of your start-up costs can only help your small business as it moves forward.

Health Insurance

Trends show that the cost of health insurance has been rising for years, and it is likely to continue to increase over time. Health insurance can be a costly expense and confusing territory to navigate. The good news is that most self-employed (independent contractors, sole proprietorships, partnerships, LLCs, corporations, and S corporations) taxpayers qualify to deduct 100% of their health care costs! This deduction can also apply to qualifying self-employed taxpayers' spouses and dependents. This deduction is one of the most commonly overlooked deductions small businesses can miss, but it can also be one of the most significant deductions they can take.

To be eligible for this deduction, you need to meet two requirements. The first requirement is that you are not eligible to be covered by a health insurance plan from an employer or your spouse's employer. The second requirement is that your business needs to have earned income. Your business's income must be more than the cost of your health insurance that you are deducting.

As a self-employed person responsible for providing you and your family's health insurance, this can be one of the most important deductions you can take advantage of. This deduction can help give you some peace of mind minimizing your overall taxable income as well as saving you money.

Bad Debt

Sometimes businesses can take a hit due to no fault of their own. This can include instances where your business has supplied a product or has performed a service and has not been paid by the customer/client. Fortunately for small business owners, this bad debt can actually be deducted in many cases. However, many small business owners are unaware that these unpaid debts can be deducted and will simply take the loss. These unpaid debts can impact not only the profitability and cash flow of a business but also the trust a business owner has in their clients. Additionally, it can negatively affect the confidence that business owner has in their ability to operate the business successfully. Thankfully there is an opportunity to make up for these unpaid debts. They can be deducted, which is good to know if you encounter the situation yourself while conducting business.

Continue reading Overlooked Tax Deductions for Small Businesses - Part II

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