Small Business Tax Guide on Business Expenses

Author: Rieva Lesonsky | June 16, 2021

Now that most of you have paid your taxes, you probably realize you need to be better prepared for the next tax season—including having a better handle on your business expenses. With companies still picking up the pieces after the pandemic and the subsequent economic slowdown, being on top of your financial matters has never been so important. Here’s a quick look at the business expenses that are deductible for 2021, what’s not deductible, and some tips on how to track your business expenses.

What are considered deductible business expenses?

The Internal Revenue Service (IRS) makes it relatively easy to determine what is and isn’t a deductible business expense. So, the key is maintaining good records to help you keep it all straight. Deductible business expenses must be “ordinary” and “necessary.” The IRS defines an ordinary business expense as one that is “common and accepted in your trade or business” and a necessary expense as one that is “helpful and appropriate for your trade or business.” The tax agency further points out that the expense does not need to be indispensable to be considered necessary.

Some business expenses examples include:

  • Fees for professional services (accounting, legal, consulting)
  • Advertising, promotion, and marketing expenses
  • Bank charges, dues, and subscriptions
  • Fixed expenses (rent, insurance, property taxes, employee commissions, and salaries)
  • Internet costs (web hosting, web design, domain names, WiFi)
  • Employee education
  • Licenses and permits
  • Maintenance and repairs
  • Office costs, utilities, postage, and supplies
  • Office security
  • Cybersecurity
  • Communications systems
  • Car mileage (56 cents a mile for 2021)
  • Business travel expenses for the owner or employees

What expenses can’t you deduct?

Nondeductible business expenses are payments used to determine the cost of goods sold, capital expenses, and personal expenses.

  • Cost of Goods Sold (COGS): Whether your business manufactures products or buys them for resale, these costs are not considered “deductible business expenses.” Instead, the materials, transportation, storage, and labor costs involved are deducted from business income and accounted for separately from deductible expenses. For sole proprietors and single-member LLC owners, COGS is accounted for in the income section of your Schedule C. Partnerships and multiple-member LLCs use partnership tax Form 1065. For corporations and S Corps, COGS is included in your corporate tax returns, Form 1120 or Form 1120-S under the income section.
  • Capital expenses: A capital expense is an expense your business incurs for the company’s future benefit instead of an operating cost needed for daily operations. Examples of capital expenses include fixed assets such as business equipment, property improvements, and patents.
  • Personal expenses: What you spend on your family and home life are not deductible as business expenses, which is why it’s so important to keep business and personal finances separate. On the other hand, these days so many business owners work from home and use their car for both work and personal matters. In those cases, it’s up to the business owner to keep careful records about what percentage of the expenses was for the business and what percentage was personal. For example, many business owners ask, “Can I deduct my internet as a business expense?” While having internet is considered an ordinary and necessary business expense in an office, the cost of the internet at home is likely a shared business and personal expense. In this case, the expense is allocated according to usage, and only the business percentage is deductible.

Some previously deductible business expenses, such as transportation costs for employees, are no longer deductible. In other words, if you pay for your commuter employees to take the subway or bus, you are a generous boss, but the cost is not a deductible business expense. Also, costs that once were considered business entertainment expenses are no longer deductible. However, if the entertainment includes food and drinks, the business owner can deduct half of the cost of the meal but none of the entertainment. If the receipt for the cost of entertainment and meal does not separate the charges, the IRS considers the entire cost entertainment, and none of it is deductible.

How to track business expenses better

Although it may seem trivial, keeping on top of business expenses is at the core of every successful business operation. Recording and regularly reviewing your company’s expenses helps you identify excessive expenditures, cut costs, and be better prepared when tax deadlines roll around. Try these tips to get your business expenses under control:

  1. Get Tech Savvy. It’s likely your company uses some type of accounting software but is your program giving you all the options and functionality you need? And are you taking advantage of all the software solution has to offer? If your accounting program seems lacking, ask your accountant or other business owners for recommendations. The best accounting programs are customizable to your needs, provide excellent support, feature helpful apps, and are cloud-based, so you can enter expense information no matter where you are.
  2. Be Detailed. No one wants to spend the time researching when an expense occurred and the exact circumstance of that expense months later, so jot down the details immediately. For example, each expense should be recorded with notes, such as “Freelance service, web design” or “Utilities, cell phone.”
  3. Separate Business and Personal Expenses. It seems like a no-brainer, but it happens from time to time that expenses fall into a gray area. If you carefully separate your records and maintain different bank accounts, you’ll cut down on any possible co-mingling of business and personal expenses. Try avoiding using your personal card and save yourself the process of being reimbursed by your company..
  4. Save Receipts. Whether the receipts are paper or digital, set aside a place to keep a copy of all your receipts. You never know when your business may be audited.
  5. Use Business Credit Cards. Using business credit cards not only builds your business’s credit score but also streamlines your expense-keeping since business credit card companies break down spending by category on your statements and usually provide a year-end summary. You can also have your statements directly downloaded into your accounting program.
  6. Reimbursing Employee Expenses. It’s vital to keep tabs on what you reimburse employees for, such as business travel expenses. Some states, such as California and Illinois, require businesses to reimburse their employees for reasonable work expenses. To legally reimburse employees for their expenditures, your business needs to create an “accountable plan.” If you don’t have an accountable plan, any reimbursements to employees are considered wages. If you and your staff follow the guidelines of the accountable plan, the expense may be deductible. However, if you don’t have an accountable plan or the guidelines of that plan aren’t followed, the costs are considered unreimbursed business expenses and are not deductible for the business or the employee.

The IRS created a specific microsite for Gig Economy entrepreneurs with helpful advice and tax guidance.

New tax credit

As part of the American Rescue Plan, small businesses can claim refundable tax credits that reimburse them (up to $511 per day, per employee) for any time off they grant employees to receive or recover from COVID-19 vaccinations. This program is in effect until September 30, 2021. There’s more information available on the IRS website.

There’s a lot of discussion in Washington right now about changing the tax code. We’ll let you know what, if anything, happens and how that affects your small business.

Fundbox and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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