Every small business owner knows that they need to take advantage of deductions around tax time, but what are deductions? And how are they beneficial?
Deduction Basics
A tax deduction is a reduction of taxable income based on certain business-related expenses that you can claim on your taxes, such as rent, business-related subscriptions, and travel.
Put simply, deductions can reduce your business’s total amount of taxable income. By claiming a deduction on your business taxes, you end up paying less to the federal government.
Tax deductions are also called “tax write-offs” or “write-offs.”
Deductions vs. Tax Credits
A tax credit is an incentive for a business to strengthen the economy, enhance people’s lives, improve society, and improve its industry in some way. Tax credits are offered by the government in an effort to reward businesses for doing good in their community and in the U.S. at large.
In short, deductions are based on expenses while tax credits are based on societal improvements. Deductions reduce the total amount of income that your business is taxed on while tax credits reduce your tax bill.
Tax credits benefit businesses dollar for dollar, while deductions benefit businesses by a percentage depending on your tax bracket. In general, tax credits are more valuable to businesses in lower tax brackets, while deductions are more valuable to businesses in higher tax brackets.
Both deductions and tax credits can help your business pay a smaller tax bill, so it’s important to work with a tax preparer to ensure you’re taking advantage of all of your options. Unsure where to start? We cover that here.
To learn more about tax credits, read this article by FreshBooks.
Is There A Master List of Deductions?
Surprisingly, the IRS does not have a master list of small business tax deductions. Instead, they provide a general rule of thumb for small business owners:
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.
Ramsey Solutions simplifies this rule best: “If something is ‘ordinary and necessary’ to running your business, then it’s a tax-deductible expense.”
The IRS does clearly state, however, what you cannot deduct:
- Expenses used to figure the cost of goods sold
- Capital expenses
- Personal expenses
If you want to dive into the details, there are many great resources out there that list different deductions for small businesses, including:
Let Us Help You with Your Business Taxes
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