Small businesses provide a critical pillar within the United States economy. According to the JP Morgan Chase Institute, small businesses comprise 99.9% of all U.S. businesses, accounting for 45% of the national GDP. However, many small business owners actually pay more tax than they need to; while large corporations tend to retain accountants, working full-time to find tax savings, many small businesses do not have this privilege. As a result, small businesses will often miss out on a plethora of potential tax savings that fly under the radar.
This article covers the most commonly missed deductions for small business owners—and how you can determine if your business is eligible.
Many small businesses conduct their operations from a home office. A home office can be located within a room at your residence or an outbuilding unattached to your home. Working from a home office provides several benefits such as flexibility, ease of access, and of course, inherent tax deductions.
However, the IRS can be a stickler for eligibility; to ensure that your home office qualifies for deductions, it must pass two tests.
In addition, your home office has to be your “principal place of business.” As your principal place of business, you must use your home office as the primary location for meeting with clients or conducting other business activities. If you perform administrative or management duties elsewhere—or have a secondary office—the IRS will reject your home office deduction.
Business travel can make up a significant expense, especially for small business owners. Luckily, there is a deduction for that; currently, the IRS permits a deduction of 56 cents per qualifying mile. This rate is subject to change each year but should remain within the same ballpark. You can easily track your business miles with a service such as Mile IQ.
Unfortunately, you cannot deduct your commute. However, there is a workaround within the tax code language; the difference lies in how ‘commute’ is defined.
Commuting travel is defined as travel to and from your home to your business. Travelling from your business to another business site, such as a branch or a meeting place with a client or prospect, is considered travel eligible for a mileage deduction. This is where a home office can come in handy; when you have a qualifying home office, business travel from your home to another place of business can be deductible because it doesn’t meet the definition of a commute.
For the sake of example, let’s say you own a restaurant 30 miles from your residence. Suppose your restaurant doesn’t have any office space, and you can do business in a qualifying home office. In that case, the 30-mile trip can count as deductible mileage instead of a non-deductible commute.
While the S-Corporation designation is not for every business, it may open the door to some next-level tax savings. Unlike standard corporations, S-Corps are considered “pass-through” entities because income, losses, and deductions “pass-through” directly to shareholders, circumventing corporate income tax. After being passed through to shareholders, income, losses, and deductions are taxed at each shareholder’s income tax rate.
The S-Corp designation can be a popular choice for certain business owners because they avoid double taxation, but it is not suitable for everyone. In fact, many businesses are not even eligible. Companies with more than 100 shareholders or foreign shareholders, ownership by a separate corporation or partnership, or multiple classes of stock are disqualified.
Even if you are eligible for an S-Corp designation, several downsides must be weighed. For example, S-Corps must run payroll and withhold taxes. In addition, the IRS closely watches S-Corps to dissuade those taking advantage of the designation. Also, outside investors tend to prefer investing in C-Corps over S-Corps because C-Corps are more conducive to growth. S-Corp profits are subject to taxation, whereas C-Corp gains are only taxed once distributed, encouraging C-Corps to keep money in the business to fund growth.
The S-Corp designation is not optimal for every business, but for highly profitable small businesses with shareholders, it can save a lot of money by circumventing double taxation.
The business meal deduction goalposts are constantly shifting, but 2021–22 is shaping up to be an optimal period for meal-related tax savings. The recent COVID-19 Relief Bill permits businesses to write off 100% of the cost of business-related restaurant meals, food, and beverages in 2021 and 2022.
By definition, deductible food and beverage items include all food and beverages, including:
Delivery charges, sales tax, and tips are also covered.
Notably, entertainment expenses are not deductible—but meals at entertainment venues can be. While it may seem like an inconvenience at the time, always ask for an itemized receipt at entertainment venues that separate the meal from the entertainment expense.
It’s always good practice to document every business-related expense, and business meals are no different. After each business meal, remember to put the receipt somewhere safe like your online accounting dashboard. Doing so is crucial to protect your finances in the event of an audit.
Giving gifts to your clients is more than a fast-track to their hearts; it can save your business money on its tax return. The IRS allows a business deduction of up to $25 per client per year.
Business clothes can also be deductible, but with many strings attached—you cannot deduct street-appropriate work clothes, for example. To qualify for the business clothes deduction, the clothes in question must be “mandatory for your job and unsuitable for everyday wear.”
Unfortunately, this means you cannot deduct a brand-new, custom-tailored Italian suit—even if it is required for your job—but a bariatric welding contractor could deduct the cost of wetsuits, for example. However, there is a workaround to deducting street-appropriate wear: if the clothing contains a visible business logo, it can be considered advertising—which is deductible.
Another deduction opportunity lies in charitable contributions. However, deducting these contributions is not as straightforward as one might expect. The only businesses that can directly deduct charitable donations are C-Corps—and most small businesses are not C-Corps.
Fortunately, there is a workaround: classifying the charitable contribution as an advertising expense. This isn’t a simple “misclassify the deduction and hope the IRS doesn’t notice” type job—which, by the way, is illegal. To successfully classify your donation as advertising spend, you must be able to show how you leveraged the donation into an advertisement.
For example, a business can accomplish this by donating money to a local high school sports or arts program, which will, in turn, list the business as a sponsor, such as in a printed program or on a scoreboard panel. In turn, the donation becomes classified as a “necessary business expense” and is now deductible as advertising spend—while still supporting a cause you care about.
Tax benefits for small businesses exist for a reason. Unfortunately, many small business owners who aren’t financially savvy—or don’t employ specialized small business accountants—miss out on what is, basically, free money. Familiarity with top tax deductions is highly beneficial for any business’s bottom line and may even help business owners scope out opportunities for further tax write-offs. Because the business tax landscape is prone to rapid, yearly change, it is crucial for business owners to keep their ears on the ground for more upcoming opportunities to save.
Jacob Dayan is a true Chicagoan, born and raised in the Windy City. After starting his career as a financial analyst in New York City, Jacob returned to Chicago and co-founded FinancePal in 2015. He graduated Magna Cum Laude from Mitchell Hamline School of Law, and is a licensed attorney in Illinois.
Jacob has crafted articles covering a variety of tax and finance topics, including resolution strategy, financial planning, and more. He has been featured in an array of publications, including Accounting Web, Yahoo, and Business2Community.
Nick Charveron is a licensed tax practitioner, Co-Founder & Partner of Community Tax, LLC. His Enrolled Agent designation is the highest tax credential offered by the U.S Department of Treasury, providing unrestricted practice rights before the IRS.
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Jason Gabbard is a lawyer and the founder of JUSTLAW.
Andrew is an experienced CPA and has extensive executive leadership experience.
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