Major Tax Deductions and Credits for Businesses
In our last post, we discussed tax deductions and credits for individuals. We will continue the tax theme in this post by discussing tax deductions and credits for businesses. There are numerous tax breaks available for businesses. Business owners can take advantage of these to significantly lower their tax bills.
Tax deductions lower the amount of business income subject to tax, while tax credits lower the tax owed dollar for dollar. A tax deduction for $100 would lower your tax liability by $100 multiplied by your tax rate. If your tax rate is 25%, you tax liability would be lower by $25 in this example.
A tax credit of $100, on the other hand, would directly lower your tax liability by $100. In the example above, your tax liability would be zero for a $100 tax credit.
Fifteen Popular Business Tax Deductions
We will take a look at 15 popular tax deductions businesses may take.
1. Operating Expenses
The most obvious deduction for businesses is their normal expenses of running the business. Expenses reduce business income and lower tax liability. There are myriads of business expenses that can be deducted, but some have limitations on how much is allowed as a deduction. For example, businesses can generally deduct only 50% of business meals.
Business owners can deduct the ordinary (common and accepted in the trade or business) and necessary (helpful and appropriate for the business) operating expenses of running their businesses. Examples include rent, utilities, office supplies, and employee wages.
This is the most extensive category of deductions for businesses. It includes all operating expenses incurred in running the business. Business owners must keep meticulous records of all business expenses, no matter the size. Even minor costs like office supplies can add up over a year.
2. Cost of Goods Sold (COGS)
Cost of goods sold are direct costs incurred to produce the goods a company sells. This includes raw materials, direct labor, and manufacturing costs.
Accurate tracking of COGS is important, especially for manufacturers and retailers. It directly impacts gross profit and can be a red flag for IRS audits if calculated incorrectly.
3. Depreciation
Depreciation allows businesses to deduct the cost of business assets over their useful lives. Instead of deducting the entire cost of an asset at once, businesses deduct the cost over several years.
The tax code allows accelerated depreciation on some assets. This means the cost of these assets can be deducted all at once instead of being spread out over several years. This helps businesses to recover the cost of these assets quicker than if they were depreciated over their useful lives.
Section 179 Deduction
Section 179 of the tax code allows businesses to deduct the full purchase price of qualifying equipment and software in the year they are placed in service, up to a certain limit. For 2023, the maximum deduction is $1,160,000, with a phase-out threshold of $2,890,000.
Bonus Depreciation
Businesses can take an additional 80% deduction for the cost of qualified property acquired and placed in service during the year. Bonus depreciation can be taken for new and used property.
Depreciation can be a powerful tool for tax planning. The ability to deduct large purchases immediately through Section 179 or bonus depreciation can significantly reduce taxable income in a given year.
As part of a tax planning strategy, businesses can opt to purchase assets in years where the depreciation would be most beneficial to them.
4. Vehicle Expenses
Businesses can deduct the cost of purchasing and operating a vehicle. The deduction can be computed using either actual expenses or a mileage rate allowed by the IRS. The Standard Mileage Rate is $0.655 per mile for 2023.
If the vehicle is used for both business and personal, the expenses must be prorated and only the business portion can be deducted.
Business owners should figure out which method will yield the larger deduction and use that one. The standard mileage rate is simpler, but the actual expense method might yield a larger deduction for newer or more expensive vehicles.
Bear in mind that the business must use the standard mileage rate the first year the vehicle is used for business in order to use it in subsequent years. Otherwise the actual expense method may be used.
5. Home Office Expenses
Business owners are allowed to deduct expenses for the portion of their home used exclusively for business. Expenses are allocated to the business on a pro rata basis, generally using square footage for the business compared to the total square footage of the home.
Expenses such as utilities, insurance, mortgage interest and property taxes are deductible.
A simplified method of $5 per square foot, up to 300 square feet, can be used instead of pro rating actual expenses. For business home use above 300 square feet actual expenses must be used.
This deduction has become more relevant with the rise of remote work. The simplified method is easier but may result in a smaller deduction than the regular method.
6. Employee Benefits
Benefits provided to employees are deductible. These include health insurance premiums, retirement plan contributions, education assistance programs and life insurance coverage.
7. Travel Expenses
Ordinary and necessary business travel is deductible at a rate of 50% for 2023. Travel expenses include transportation, lodging, and meals. Business owners should keep detailed records, including the business purpose of each trip.
8. Advertising and Marketing
Costs for promoting a business are deductible. This category is broad and include digital marketing, which is increasingly important. Be careful with items that might be considered entertainment, which is not deductible.
9. Insurance Premiums
Business insurance expenses are deductible. These include business liability insurance, commercial property insurance and business interruption insurance.
10. Professional Fees
Legal, accounting, and consulting fees are deductible.
11. Rent Expense
Office space and equipment rentals are deductible.
12. Interest on Business Loans
Mortgage interest on business property and interest on business credit cards and loans are deductible. Larger businesses have restrictions on deductible interest imposed by recent tax law changes.
13. Taxes
Certain business-related taxes are deductible. These include property taxes on business assets, payroll taxes and state and local taxes related to a business.
Federal income taxes are not deductible for businesses.
14. Education and Training
Costs for improving skills related to a business are deductible.
15. Bank Fees
Charges for maintaining business bank accounts and credit cards are deductible.
Eleven Popular Business Tax Credits
Businesses can avail themselves of tax credits to reduce their tax bills. Business tax credits come in many different shapes and sizes. There is probably a tax credit for every business. The rules for qualifying can be stringent for some of these credits, so businesses must make sure they are following the rules when claiming these credits.
Here are eleven business tax credits.
1. Research and Development (R&D) Tax Credit
Up to 20% of qualified research expenses can be claimed as a tax credit. Unused amounts can be carried forward for up to 20 years.
Many businesses do not realize that this credit is available. Even if a business is not in a traditional R&D field, it might still qualify if it is developing new products or processes.
2. Work Opportunity Tax Credit (WOTC)
This credit is allowed for hiring individuals from certain target groups who face significant barriers to employment, such as veterans, long-term unemployed, and individuals receiving government assistance. The credit is generally 40% of first-year wages up to $6,000, but in some cases may be as high as $9,600 per employee.
This credit can provide significant savings while also supporting workforce diversity. However, it requires certification from state workforce agencies.
3. Small Business Healthcare Tax Credit
This credit is available for small employers who provide health insurance coverage for employees. To qualify, businesses must have fewer than 25 full-time equivalent employees, pay average wages of less than $56,000 per year, and cover at least 50% of the employees’ health insurance premiums.
Employers can deduct up to 50% of premiums paid (35% for tax-exempt employers).
This credit can make offering health insurance more affordable for small businesses, but it has strict eligibility requirements.
4. Disabled Access Credit
This credit is for small businesses that incur expenses to provide access to persons with disabilities. Businesses can deduct 50% of eligible access expenditures that exceed $250 but don’t exceed $10,250, for a maximum credit of $5,000.
5. Employer-Provided Childcare Facilities and Services Credit
Businesses can claim a credit of 25% of qualified childcare facility expenditures, plus 10% of resource and referral expenditures. The credit is limited to $150,000 per tax year.
This credit can be a significant benefit for businesses looking to support working parents, but the administrative requirements are complex.
6. New Markets Tax Credit
Businesses can claim a 39% credit over seven years for investments in community development entities. This credit is designed to stimulate economic growth in low-income communities. It is complex but can provide substantial benefits for qualifying investments.
7. Renewable Energy Investment Tax Credit (ITC)
Businesses can claim a credit for solar, wind, and other renewable energy investments. The percentage that can be claimed varies by technology and project start date.
This credit aligns financial incentives with environmental goals. The percentage varies, so careful planning is essential to maximize the benefit.
8. Energy-Efficient Commercial Buildings Deduction (Section 179D)
Businesses can claim a tax credit of up to $1.88 per square foot for energy-efficient improvements. This credit can provide significant benefits for new construction or major renovations, but requires certification by a licensed engineer or contractor.
9. Employee Retention Credit
This credit can be claimed by businesses that kept employees on payroll during COVID-19. While this credit has expired, it can still be claimed retroactively. It provided substantial benefits for many businesses during the pandemic.
10. Family and Medical Leave Credit
This credit can be claimed by employers who provide paid family and medical leave to employees. Businesses can claim up to 25% of wages paid during leave.
11. Alternative Fuel Vehicle Refueling Property Credit
This credit is available for installation of electric vehicle charging stations or other alternative fuel equipment. Businesses can claim 30% of costs up to $100,000 per location for installation of charging stations.
IMPORTANT CONSIDERATIONS
Eligibility
Each deduction and credit has specific eligibility requirements. Businesses should ensure that they qualify before claiming a tax credit.
Documentation
Business should maintain thorough records to support all deductions and credits claimed.
Tax Law Changes
Businesses should stay informed about potential changes to tax laws that may affect deductions and credits.
State-Specific Benefits
States have their own tax deductions and credits. Businesses should check their state’s tax rules for additional deductions and credits.
Timing
Some deductions and credits may be more beneficial if timed strategically across tax years.
Alternative Minimum Tax (AMT)
Business owners should be aware of how AMT might affect their ability to benefit from certain deductions and credits. A tax professional can help businesses better understand the nuances of the AMT. We will discuss the AMT in a future article.
Carryforwards and Carrybacks
Some unused credits and deductions can be carried forward to future tax years or back to previous years.
Complexity
Many business tax deductions and credits have complex rules. Business owners should consult with a tax professional to ensure they are in compliance with the rules and also to maximize benefits.
Final Thoughts
Navigating business tax deductions and credits can be complex, but the potential savings make it worthwhile. Businesses should keep detailed records and work with a tax professional to ensure they are maximizing the benefits while remaining compliant with tax laws. Tax laws change frequently, so businesses should stay informed about current regulations and how they apply to specific business situations.
Tax strategy should be tailored to unique business circumstances, and regular consultation with a tax professional can help business owners develop a comprehensive tax strategy that goes beyond just claiming available deductions and credits.
This article is for educational purposes and is not financial or tax advice. Business owners should always consult with a professional to ensure they are compliant with tax laws and regulation.
