Small Business Expenses: The Most Important Deductions and How to Track Them
According to the U.S. Small Business Administration, only half of all small businesses survive for at least five years. That longevity is more encouraging than baseless survival stats that tend to get tossed around (e.g., “90% of all small businesses fail in their first year!”), but it indicates the difficulty of keeping a small business afloat.
To maximize your chance of success when you have tight margins and you’re operating in a competitive business environment, track all your expenses. Tracking gives you insight into areas of improvement and allows you to take advantage of significant tax deductions.
In this post, we’ll cover the common expenses you should be deducting and the tools that can help you keep track of everything.
Why track all of your small business expenses?
Expense tracking helps with budgeting, forecasting, and general financial planning. If you know where, when, and how you are spending money, you can more accurately predict future cash flow and make your operation more efficient.
Expense tracking can also help reduce your tax bill through the process of deductions: subtracting from you bill what you spend on equipment and services related to running your business. You might be surprised at how many small business expenses you can deduct.
And the better records you keep, the more you can save come tax time.
Small business expenses you can deduct
According to the IRS, deductible business expenses must be “both ordinary and necessary.”
This means that the things you purchase must be standard for your line of work. You can’t open a bicycle-repair shop and expense the installation of a wood-fired pizza oven, for example.
Take advantage of these common small business deductions to reduce your tax bill.
If you use a section of your home exclusively as an office for running a business, deduct the expenses associated with the office. This once-complicated process has been simplified by the IRS, which now allows you to deduct a standard $5 per square foot for the parts of the home you use to run your business.
Portions of your costs for the internet and other services needed to create a fully functioning home office can also be deducted.
Utilities and Supplies
Money spent on electricity, water, gas, telephones, and other utilities for your office are all deductible. Similarly, you can deduct other necessary expenses for running your business, such as traditional office supplies, as long as they are used within a year of purchase.
Cost of Goods Sold
Deduct what you spend on producing your goods and holding your inventory. This includes:
- Raw materials
- Factory costs
Use form 1125-A to factor in deductions for cost of goods sold.
Meals at your place of employment are deductible at a rate of 50%. And if you go to an entertainment event that is part of a legitimate business outing, you can also deduct those meals.
If you have a vehicle you use for business purposes, deduct the cost of operation, including the depreciation of the vehicle. Expense even the miles you drive for business purposes at the current standard rate of 54.5 cents per mile.
If you need to hire a consultant to rework your sales process, an online bookkeeping service such as Pilot to manage your books, a research team to develop a new product, or an attorney to help you through a lawsuit, deduct those costs.
If you travel for business, such as attending a conference or trade show, track your expenses and deduct them. This can include the cost of hotel rooms, tickets, and foods. Just know that in order to qualify, you have to be able to prove that the travel was work related.
You are allowed to deduct the amount you pay to use buildings that you do not own. This covers expenses like office rent and factory rent. Note that if you have equity in the buildings you are renting, you cannot deduct the expenses as rent.
Employee salaries can be deducted from your taxes. Just know that the salaries have to be deemed reasonable by the IRS, meaning you are paying what another business would likely pay. You can’t hire your friend, pay them $10,000 per month to be your personal life coach, and then deduct it as a reasonable business expense.
The costs of paying for an employee retirement plan, such as a 401(k), can be deducted. Plus, you can expense other benefits, including childcare, employee education, workers’ compensation, and conveniences like parking and commuter benefits.
Your business needs to be insured, so deduct the amount you spend on things like fire, storm, theft, accident, liability, malpractice, and health insurance.
Interest on loans
Many businesses borrow money to support growth. If you do, you can deduct the interest you pay on the loans.
Charitable giving can be deducted, as long as you use the IRS’s tax-exempt organization search to find qualifying organizations. Once you have done that, deduct gifts, cash, and travel expenses related to working with the charity.
Small business expenses you can capitalize
Some small business expenses cannot be directly deducted, but you can still leverage them for a tax break. A common way to do so is through capitalization, whereby you track the depreciation and amortization of assets and subtract the costs from your tax bill.
The following are commonly capitalized expenses:
Capitalize activities necessary to start your business. These include trainings, travel to distributors or for research, market surveys, and advertisements promoting the coming business.
These can be physical assets, such as vehicles and buildings, or intangible assets, such as patents, licenses, and trademarks.
You are incentivized to invest money in improving your business because the IRS lets you capitalize the costs. Note that this is different from routine maintenance, which cannot be capitalized or deducted.
Helpful tools for tracking small business expenses
Running a small business is hard enough. Don’t make it extra difficult by tracking your expenses on scraps of paper, crumpled receipts, and hastily thrown-together spreadsheets. Use the following tools to streamline your expense-tracking process.
Teampay helps companies track spending in real time. They can automate approvals and help to improve your purchasing process. They also offer a virtual card that can help control spending and reduce end-of-month reconciliation headaches.
Expensify lets employees quickly log expenses. The company’s differentiator is a smooth and intuitive app that can snap a picture of a receipt, extract the relevant information, and automatically upload it to a database. The user doesn’t have to manually enter any information.
Logging expenses is one thing; incorporating them into your bookkeeping system is another. Pilot’s bookkeepers can consult with you on deduction strategies, provide you with a custom system that efficiently organizes your expenses, and make it easier for you to save money come tax time.
Every dollar counts
One of the top reason’s that startups fail is that they run out of cash. That’s a shame because most small business owners are passionate about what they do and have the potential to make a real difference in the world, as long as they can keep the cash flowing in. By tracking your expenses and taking advantage of deductions, your business has the best chance at defying the odds and surviving well past the five-year mark.