As a small business owner, changes to the federal tax code and new federal business tax deductions will have you feeling like you have homework to do. But sweeping changes in the recently passed federal tax plan has entrepreneurs (and tax accountants) everywhere feeling like they are cramming for midterms. With that in mind, we created a study guide of sorts: let’s just call it your 2021 small business tax deductions checklist! Read on to see how your small business can best benefit from brushing up on these laws.
Put simply, small business tax deductions are items you can use to reduce your tax obligation by compiling and writing them off on your returns.
There are varying laws limiting or enhancing certain types of purchases, rent, and financial loss, so working with a tax professional to understand the best ways to use deductions is recommended.
Here are some of the most common and valuable tax deductions for a typical small business:
- Home Office: if you are a sole proprietor or a business owner that does any work from home (we’re guessing during covid-19 this is most people), you can deduct a portion of your rent from your tax bill.
This is typically done calculating the ‘devoted’ work space of your home, meaning it has to be used consistently for business purposes.
- Vehicle Expense: These can include commuting miles, gas, or errands conducted while using your own car. Parking expense and depreciation can also be applied in certain circumstances, though they are exempt from certain business types. As will all deductions, check with your accountant or tax consultant for how to best accrue these expenses.
- Office Supplies and Expenses: This is one of the broadest and useful categories for any business. While proper documentation is required for all write-offs, this can be nearly anything utilized for your business. Furniture, computers, staffing supplies, or conventional office purchases qualify to be deducted. Anything else that you can legitimately justify as necessary for your business can likely be deducted from your tax return, so long as it is on that list.
- Rent, Utilities, and Professional Services: Once more, with proper documentation you can save a bundle on your taxes by removing a portion of the cost to exist as a business. Any office space, vehicle rent, business utilities (including internet), or consulting can be written off to some degree.
- Depreciation: In the event your business buys new capitalized equipment- usually appliances or vehicles- you can get a depreciation break from them. There are specific requirements for deduction stipulated by the IRS, but certain items can be 100 percent written off.
Now that we’ve gone over the most common business tax deductions, let’s take a look at the most updated ways tax law applies to them.
President Trump signed the Tax Cuts and Jobs Act into law in December of 2018. The legislation has allowed businesses and employees to take advantage of broader tax brackets and lower rates. Savings as a result of this federal business tax reduction have begun to hit balance sheets for 2018 and 2019 tax returns, but it is important to know how to leverage these changes effectively.
Planning and forecasting are paramount to efficient operations. If you haven’t already been proactively utilizing the TCJA ruling to update your accounting, keep these deductions in mind as you are planning for the coming year.
One of these deductions might enable you to finally invest in that shiny new piece of equipment or make a strategic new addition to your team, or relieve budgeting pressure. As we have been hit with a global crisis that was especially hard on small business pocketbooks in 2020, it is especially important to know every avenue of financial relief the government will afford.
Among one of the most talked about changes in the TCJA was the qualified business income deduction. Familiarizing yourself with it is important to see how it impacts both you and your business.
Most businesses are structured as LLCs, partnerships or S-corporation — organizations known collectively as pass-through entities. This means that rather than the federal government taxing their income at a business rate and then again at an individual tax rate, income passes through directly to a business owner. That owner then reports the income on individual returns and pays the individual rate. This is, of course, after computing any deductions for expenses to run the business. In short, income is treated like direct income to the individual business owner. The feds tax the income in question at the individual rate only, adding to the impact of federal business tax deductions for pass-through entities.
Under the new federal tax plan, Section 199A holds that business owners with companies organized can deduct the first 20 percent of qualified business income. Sounds great, right? But the deduction does come with some significant restrictions. The law treats differently specified services or businesses like attorneys, consultants, performance artists and others who provide services under the tax plan. For those types of businesses, the deduction is not available unless the total amount of qualified business income falls below the phase-out thresholds, set based on marital status. It is worth noting that since the inception of this bill, the rates have been adjusted to reflect single and married family baseline deductions, so please consult with your account on how best to itemize this.
The deduction phases out based on total income levels (not just business income). If you are single, the phase-out of the deduction starts at a total income level of $157,500 and is completely phased out at $207,500 and above. For married couples filing jointly, the phase-out begins and is complete at $315,000 and $415,000 respectively.
A federal business tax deduction under Section 179 of the tax code allows businesses the opportunity to deduct 100 percent of the costs to buy certain qualifying equipment and software that support company operations. This comes with a couple of caveats that (according to some) work in favor of small businesses in most industries.
The deduction is limited to $1 million, which typically would have an impact on most small businesses. Additionally, the largest amount a company can spend on these types of investments and still qualify for the deduction is $2.5 million. That means that in most cases, large businesses cannot spend $4 million on new equipment and still take advantage of the deduction. The investment in question must be for equipment or software purchased and put into use before the end of the year.
One issue that was present in 2018 was the uncertainty of how much a small business could deduct, as there was supposed to be a sliding scale for the next eight years. However, congress has allowed some stability and stress-relief for small business owners, as in 2020 (and for the foreseeable future) the $1,000,000 threshold remains static.
After caps are reached for Section 179 deductions, businesses typically move on to bonus depreciation deductions. Before passage of the tax legislation, the bonus depreciation deduction required property in question to be “original use.” The new law eliminates this rule, meaning that you can now deduct bonus depreciation on new and used property. And while this is not permanent, the deduction is not slated to begin phasing out until 2023, phasing out for good in 2026. Once more, with our 2020 economic crisis impacting legislature, the scaling of this has been halted and the rate remains fixed at 100 percent.
Under this section of the tax law, business owners can immediately deduct half of the expense of certain types of property. Before this law was enacted during the Great Recession, companies took smaller federal business tax deductions over the course of years. This section of the tax law was supposed to begin phasing out this year, but the Tax Cuts and Jobs Act extended it.
These new tax deductions can have a big impact on the way you run your business in 2020 and beyond. Especially as some of the concerns for scaling in the additional bill have been alleviated, now is the time to educate yourself about how to properly implement them. We always recommend working with qualified professionals to assessing what this tax leverage can provide you.
If you have any questions about these deductions specifically, or federal tax laws in general, please reach out today. Paytech has your back, and has helped innumerable small businesses succeed in every tax environment for decades!
Contact us to start a conversation about how one of our qualified Arizona accounting professionals can help your business succeed in 2021.