Common Deductions For Business Owners - Part 2 of 2

There are two things that small business owners consistently ask me: “How do I keep track of my records” and “what qualifies as a business expense”.

Record keeping is a pain.  You need to keep track of receipts for 7 years.  Some people prefer the manual method and keep track of everything on paper and some use Excel.  (I have created an excel template to give to small business owners.  Let me know if you need it.)  I recommend using Quickbooks Online.  It’s easy to setup up, easy to use and will connect to your bank account.  If you’re interested in learning more about QBO, let me know.  I can get wholesale pricing.

With QBO you can take a picture of a receipt and attach it to a transaction, eliminating the need to keep track of all of those receipts.  

Business expenses – basically anything that is “ordinary and necessary”.  “Ordinary” means they are common and accepted in the general industry in which the business owner is working. “Necessary” means they are appropriate and required in operating your small business.  I’ve created a whitepaper detailing what exactly that means and am attaching it.

In the previous article Part 1, I have shared with you some of the list of specific expenses you can deduct as a business owner. As promised, I will be sharing with you more in Part 2.

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Meals and Entertainment

Ordinary and necessary entertainment includes any activity generally considered to provide amusement, entertainment, or recreation, including meals provided to a customer or client. 

For entertainment expenses to be deductible, there must be a clear business purpose for them, and substantial business discussions must be held before, during, or after the entertainment. The expenses can’t be lavish or extravagant, and the tax deduction is generally limited to 50% of the expenses incurred.

The cost of business gifts to current or prospective customers is deductible up to a maximum of $25 per customer per year. Tickets to shows or sporting events given to clients to promote business are deductible. If the business owner accompanies the customer to the event, the cost of the tickets is deductible as an entertainment expense. If the business owner doesn’t accompany the client, the cost may be deducted as either an entertainment expense (subject to the 50 percent limitation) or as a gift (subject to the $25 maximum), whichever is more advantageous.

Utilities

To be deductible, compensation must be an ordinary and necessary expense of carrying on the business, reasonable in amount, for personal services actually rendered, and actually paid or incurred during the tax year. Gross salaries, wages, or other compensation paid to relatives (including the business owner’s spouse and children) are deductible provided all these requirements are met.

The actual cost of meals and lodging furnished to employees is deductible as compensation paid regardless of whether the value is taxable to the employee. The value of meals and lodging furnished for the employer’s convenience is not included in the employee’s gross wages. If furnished as additional employment incentives, the value is included in wages.

Wages

To be deductible, compensation must be an ordinary and necessary expense of carrying on the business, reasonable in amount, for personal services actually rendered, and actually paid or incurred during the tax year. Gross salaries, wages, or other compensation paid to relatives (including the business owner’s spouse and children) are deductible provided all these requirements are met.

The actual cost of meals and lodging furnished to employees is deductible as compensation paid regardless of whether the value is taxable to the employee. The value of meals and lodging furnished for the employer’s convenience is not included in the employee’s gross wages. If furnished as additional employment incentives, the value is included in wages.

Other Expenses

Examples of tax deductions that might be listed as other expenses are:

     • Bank service charges (including the service charge for accepting credit cards).
     • Dues to trade or professional organizations.
     • Subscriptions to publications.
     • Trash removal fees.
     • Laundry and cleaning expenses for uniforms.
     • The cost of food consumed by day-care recipients (other than the provider’s dependents) in a day care. 

Bad Debts from Sales or Services

Customer accounts receivable and notes receivable that are definitely known to be worthless are business bad debts and are deductible if the income was included in gross income. Generally, only accrual method business owners have a bad debt deduction. A cash method business owner is not entitled to claim a deduction for business bad debts because the sale was never included in income.

Start-up Expenses

When someone begins a start-up business, he or she often incurs expenses just to get the business up and running. As part of the American Jobs Creation Act, taxpayers can deduct up to $5,000 of start-up costs and $5,000 of organizational expenses incurred in the first year of their small business.  Start-up expenses are the costs the business owner has for setting up an active trade or business. If these costs meet the following tests, they may be recovered through a process known as amortization:
 
Examples of costs that may qualify as start-up expenses include the following:
 
     • A survey of potential markets.
     • Analysis of available facilities, labor, supplies, etc.
     • Advertisements for the opening of the business.
     • Salaries and wages for trainee-employees and their instructors.
     • Travel and other necessary costs for securing prospective distributors, suppliers, or customers. and fees for executives and consultants and for other professional services.
 

Start-up expenses do not include deductible interest, taxes, or research and experimental costs. Expenses not deductible within the first year can be amortized over 15 years.

Car and Truck Expenses

A business owner who uses his or her automobile or reimburses an employee for using an automobile has two methods available for claiming car and truck expenses. The two methods are actual expenses or the optional method.

Actual Expenses
– A business owner who uses the actual expense method will claim the business portion of the actual expenses paid to run the vehicle. Actual expenses include the cost of gas, oil, insurance, tires, licenses, repairs, garage rent, and cleaning. If the car is rented, the lease or rent amount can also be a tax deduction (within limitations).  If the business owner owns the car, he or she may claim a depreciation tax deduction.

Optional Method (Standard Mileage Rate)
– The second method is known as the optional, or standard mileage rate, method. Business owners who own or lease their cars and who don’t operate a fleet of vehicles for their businesses are eligible for this method.

The standard mileage rate for 2021 is 56 cents a mile. Business owners should take this into account when calculating their income and expenses or paying the expenses of employees.

Additional Expenses
– The standard mileage rate is considered to cover most of the ordinary expenses listed under the actual method. However, certain expenses may be claimed using either method. These expenses include: 

Parking fees and tolls

The business-use percentage of finance charges paid on the purchase of the vehicle.
The business-use percentage of personal property taxes on the vehicle.

Actual Expenses Depreciation

Depreciation is the annual tax deduction allowed to recover the cost or other basis of business property with a useful life of more than one year. Generally, assets placed in service after 1986 are depreciated using the Modified Accelerated Cost Recovery System, MACRS. The term “MACRS” essentially refers to two different depreciation systems, the General Depreciation System and the Alternative Depreciation System.

The General Depreciation System is the most common and applies the depreciation rate against the asset. The Alternative Depreciation System is different in that the depreciation is deducted over longer periods of time. This system is generally used for listed property where the business use drops to below 50 percent and for situations where the General Depreciation System cannot be applied. But it doesn’t apply if the standard tax deduction is claimed.

If you have any questions or need help with your small business, please don’t hesitate to call 502
867-1827 or email katherine@kmjohnsoncpa.com

 

I’m Katherine Johnson and own Katherine M. Johnson, CPA. I have had my business since 1996 and an office on Main Street since 2014. I specialize in helping small businesses get their accounting/bookkeeping set up, and in some cases do it for them if they prefer. We do payroll and other business related tasks as well. I do taxes and tax planning for individuals and small businesses, and also try to help people with issues with the IRS or state/local agencies. I’ve been in Scott County since college and made it my home for many years. I just recently moved to Frankfort. I raised a son that is now 21 at WKU and a senior. I remarried in 2020 to a wonderful man from Frankfort and now have two stepdaughters and two grandkids. Life is good!