Business Tax Deductions and Credits
Ever wondered what your accountant does behind the computer screen when it’s time to file for taxes? Don’t worry, we won’t take you through an accounting lesson, however, what we can tell you about are business tax deductions and credits.
Many businesses may find it overwhelming to start learning about taxes and the like. Although, it isn’t something you can turn a blind eye to. After all, it’s your business, and you deserve to know how the government may charge your business checking account.
As a bonus, we’ll also let you in on some strategies to keep paying taxes at a minimum. Here’s all you need to know about business tax deductions and credits.
An Overview of Business Tax Deductions and Credits
Before we dive into the details, let’s quickly examine what business tax deductions and credits are.
Business Tax Deduction
Let’s start with business tax deductions. A business tax deduction is the amount you can reduce from your taxable income for the yearly tax return. You can reduce your taxable income by cutting out business expenses when you file your tax return.
Here are some business expenses that you can use to lower the amount you owe to the government:
- Transportation costs
- Medical costs
- Supplies for office
- Vehicle expenses
- Advertising costs
We’ll get into the details of the different types of tax deductions later.
Business Tax Credit
Business tax credits and tax deductions are often confused with one another. This is, of course, understandable because both are essentially reducing your tax burden in some form.
Now that we already have an idea of tax deductions, it's time to unravel how tax credits work.
Simply put, tax credits – also referred to as targeted tax credits, are a provision that reduces the amount the taxpayer owes from their final bill.
Unlike tax deductions subtracted before the tax bracket, tax credits are deducted dollar for dollar.
The main difference lies in the fact that tax deductions affect taxable income. While tax credits reduce the tax liability directly.
Types of Business Tax Deductions
Now that we have our basics cleared, it’s time to scratch some more details. We’ll review some business tax deductions you can add to your annual tax return. Although, keep in mind that your business may not be eligible for all the tax deductions we list down.
Supplies for Office
One of the most common and recurring types of tax deduction is the amount you spend on buying supplies for your office. Several things can count as being important equipment for the office, such as :
- Printer paper
- Office furniture
Business Food Expenses
Any meal that you have for business purposes can count as a tax deduction. As long as you keep track of the meal details, such as the place, time, and people (and their connection to your business) you ate with, you can qualify for adding this expense to your tax deduction.
Travel and Vehicle Costs
This one is applicable if you share the same thirst for traveling as Columbus or Marco Polo, or at least travel as much as they did. If you spend more than one business day outside of your city and spend money during this time, such as hiring a taxi or lodging, you can add that to your tax deduction list as a travel expense.
If you use a vehicle for handling business operations such as delivery, you’ll be eligible to cut the costs of maintenance and functioning of the car on your tax return. However, in case you use a car for both business and personal use, you’ll have to separate the miles driven for business purposes and can only cut the costs associated with the miles driven for business.
All businesses engage in marketing. Not spreading the word about your brand is like opening a shop with no banners. Any costs incurred from printing advertisements, promotions, and online marketing can be considered a tax deduction.
You might even hold corporate events at times which may require additional investment. As long as you can establish the relation between the expenses of such functions and your business, you can easily add them as tax deductions.
This shouldn’t come off as a surprise, but your office utility bills also fall under the tax deduction category. Therefore, you can write off all electricity, water, phone, and internet bills in your office.
Note that similarly to vehicle costs, if you use the internet for business and personal use, you’ll have to separate the usage of both and can only deduct the amount you use for your business needs.
Home Office Deductions
After the Covid-19 pandemic, the IRS streamlined the guidelines for home office deductions.
This is exclusively for small organizations or freelancers who use their house space to operate their businesses and allows a deduction of $5 per square feet of their home occupied.
Let’s say you keep your product supplies and manage all documents in one room. This space that you occupy can be labeled as “office space.”
The key thing to note here is that only the area regularly used as an office is qualified. In other words, you cannot add square feet of space serving business and personal requirements. Hence, it won’t be eligible for this tax deduction.
To figure out and file the home office tax expenses, you must fill out the IRS Form 8829. Complete the Schedule C part (sole proprietors). For partnership, Form 1065 and Schedule E (rental income) has to be filled, respectively.
Eligibility Requirements for Business Tax Deductions
Now if you’re looking at a business expense and are thinking, “Does this come under tax deductions too?” we’ll clarify things.
According to the IRS (Internal Revenue Service), any expense can only be eligible for deduction when it is necessary and ordinary. Necessary expenses would be those that assist you in your trade or business, while ordinary expenses are the ones that usually come up in the industry you’re in.
For instance, let’s assume you run a clothing brand. In this scenario, the cost of manufacturing, raw materials for making a product, and delivery costs would account as necessary and ordinary costs. Conversely, in the same circumstance, you cannot deduct the expenses of your personal car to travel to the shop.
In general, expenses that come under the following category cannot be “deducted” from your tax return:
- Personal expenses
- Capital expenses
Common Business Tax Credits
The IRS (Internal Revenue Service) goes over how businesses can claim business tax credits by filing the relevant form and checking if they’re eligible.
For the most part, business tax credits come under the general tax credits. But there are numerous categories of tax credits that you can claim, including:
Work Opportunity Tax Credit
The “Work Opportunity Tax Credit” comes under the general business credit that can be claimed by companies that hire individuals from specific targeted groups. The tax credit is available to those who have joined on or before December 31, 2025, with the maximum tax credit being around $2,400.
Since this effort is to encourage workplace diversity, an employer hiring someone from the following groups can claim this WOTC under section 51 of the code:
- Formerly incarcerated or ex-felon
- People who have been unemployed for a long-term
- Residents of rural renewal counties or empowerment zones
How to Fill the IRS Form 8850
- Employers have to go through a set of pre-screening with the job applicant and obtain a certification from the State Workforce Agency to certify that the applicant is a member of a targeted group.
- After the confirmation, taxable employers must file Form 5884, while tax-exempt employers must file Form 5884-C.
Research and Development Tax Credit
The R&D tax credit significantly reduces a company’s tax liabilities by the government to encourage innovation and increase employment opportunities. In short, it is a tax incentive that reduces your taxes at both state and federal levels.
Generally, expenses like design, or improvement of products, software, etc., are included in this tax benefit.
For claiming the R&D tax, your business should prepare all the documentation that has accounts for the qualifying costs for the tax credit. They are as follows:
- Financial records
- Business data
- Project lists and notes
- Technical reports or records
All small to midsize companies are eligible for this tax benefit, and you must file the IRS Form 6765 (Credit for Increasing Research Activities).
How to Fill the IRS Form 6765
The R&D tax credit form has four parts and is categorized as follows:
- Section A: It is to document the regular credit
- Section B: Calculate the average research credits by Alternative Simplified Credit (ASC) method
- Section C: Important records such as employee wages are added to the current year's credit
- Section D: This is only for qualified small businesses doing a payroll tax election
Employee Tax Credits and Deductions
Now, what’s in there for employees? Do they receive any type of tax credits or deductions?
The IRS has multiple tax credits and deductions for individuals that can cut down your tax burden, such as:
Tax Credits for Individuals
- Income and Savings Credit
- Healthcare Credits
- Family and Dependent Credits
- Homeowner Credits
- Clean Vehicle and Energy Credits
Tax Deductions for Individuals
- Education Deductions
- Healthcare Deductions
- Investment Related Deductions
- Itemized Deductions
- Work-Related Deductions
Depreciation and Amortization Deductions
We’ll go over both of these deductions one after the other.
Depreciation refers to the loss of value of an asset over the years, which gradually reduces the cost of that fixed asset. This depreciation expense is considered an allowable tax deduction by the IRS, which allows businesses to recover an asset's cost.
In the case of amortization, you’re dealing with intangible assets such as copyrights or patents that the business owns. However, for these kinds of assets, the calculation is based on lowering the value by the same amount yearly.
For your company to claim the tax deduction, you need to verify how the asset is classified. When you’re done calculating the depreciation accordingly, you have to fill the Form 4562 to report the deduction along with your tax returns.
Tax Planning Strategies for Business Tax Deductions and Credits
Okay, enough with the theoretical knowledge. Where are the sweet strategies for keeping taxes at a minimum?
Don’t worry, we haven’t forgotten our promise, we’re better at remembering words than numbers, after all. Now, let’s explore some strategies for business tax deductions and credits.
Get a Tax Expert
If you haven’t heard this advice yet, then you’re bound to at some point in the future. We cannot stress the importance of having a tax consultant on board. Getting one will ensure that your business takes complete advantage of all the tax deductions and credits to the maximum.
You can also work with your tax consultant and accountant to create a customized tax strategy that best suits your company’s needs.
Make Smart Investments
As mentioned above, depreciable assets can also help you reduce tax over time. Assets such as machinery and equipment come within this group. When you buy a piece of new equipment, you cannot “deduct” its entire amount within the year of purchase.
What you can do is spread its total cost over the lifetime of its usability. With time, you can keep lowering the costs and, in turn, reduce the overall tax amount due.
Planning the Expense and Income Dates
You can push your income to the next year and bring more expenses in the current year. This will enable you to take advantage of tax deductions and maximize them for the present year. Further, you won’t come under a heavy tax bracket since your income is low on paper.
Wrapping Things Up
Tax credits and deductions are different financial benefits that you can use to lower your taxes.
As a business, keeping all necessary documents and records can give you an upper hand in managing your tax returns efficiently.
Further, having a tax consultant will also help you develop strategies that minimize tax liabilities. It is crucial for firms to have an idea of how a business checking account works. You can find detailed reviews of different banks here to learn more about such financial institutions.
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