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Small Business Tax Deductions
Business owners often wonder how many tax deductions they can write off against yearly income taxes. They can do this by taking either a current or a capital expense. A current expense benefits the business, such as paying employees’ salaries. A capital expense does not benefit the business directly, like buying equipment. A tax attorney has prepared the article below to provide additional information about this common issue. Please remember that this article is for informational purposes, and you should consult directly with your tax attorney and advisors about your specific issues.
The IRS allows businesses to take both kinds of deductions. But there are some essential differences. Here’s why.
Current Tax Deductions
Small businesses often spend money every month without knowing how much it costs to run the business. They don’t know what percentage of their revenue goes toward paying bills, utilities, or marketing. Many small businesses don’t even track these expenses. But you do need to know where your money is coming from. You can use the IRS’s Form 1040 Schedule E to calculate your current expenses.
The term “current expenses” refers to all of your expenses that occur each month. This includes rent, mortgage interest, insurance, maintenance, supplies, advertising, salaries, taxes, etc. Your current expenses include both fixed and variable expenses. Fixed expenses, such as rent and mortgage payments, remain constant throughout the year. Variable expenses, however, fluctuate based on an activity in the business. For example, if you’re selling products online, you might pay different amounts for shipping depending on whether sales are high or low.
You can determine your current monthly expenses by adding up all your monthly expenditures. Then, divide those figures by 12 to determine how much you spent per month.
Consider the following scenario if you’re wondering why anyone would want to deduct current expenses from gross income. Let’s say you start a business making widgets. You make $10,000 in profit for the year. However, you incur $5,000 worth of expenses. You’d have nothing left over if you deducted all of your expenses from your gross income. Instead, you could take the difference between your gross income and current expenses and report that figure on your federal tax return. That way, you’ll still have some money leftover to invest into the following year’s business.
Capital Tax Deductions
The IRS considers capital expenditures to be investments in the business. This means you cannot write off the total cost of an asset upfront. Instead, you spread out the expense over several years.
This allows businesses to ensure they’re profitable each year based on actual cash flow. If you don’t do it correctly, your taxes could look very different than what you expected.
If you don’t know whether something qualifies as capital or current expense, ask yourself: Does the item help me run my business? Is it used to produce goods or provide services? Or does it just sit around collecting dust?
Examples of Capital Tax Deductions
Capital expenditures are investments businesses make to improve their operations. For example, a manufacturing plant may purchase new machines, computers, or software. These purchases add to the value of the business, increasing the owners’ net worth.
Businesses often use cash flow to pay for these expenses. They borrow money to fund capital improvements and repay the loan over time. When you sell a business, the buyer takes ownership of the assets purchased during the sale process. If the seller didn’t include the cost of those assets in the sale price, the buyer must account for the difference.
More Questions About Tax Deductions?
A tax deduction isn’t just about getting money back from Uncle Sam; it’s also about keeping accurate records of what you spend on your business. If you’re running a small business, there are certain deductions you’ll want to take advantage of, such as those related to advertising, rent, utilities, supplies, travel, employee benefits, etc. However, some things aren’t deductible, including meals and entertainment. You can deduct the cost of goods sold but not the cost of items like clothing, computers, office equipment, furniture, and even postage stamps.
If you have questions related to a deduction or capital expense, you can speak with a tax attorney or business attorney by contacting The McGuire Law Firm. The McGuire Law Firm offers a free consultation with a tax attorney to discuss your questions and issues. Call us at 720-833-7705.