I know small business owners are super busy running their operation, planning their strategy and making sure they earn a healthy profit. As a result, understanding and staying up to date on the latest tax rules is not always top of mind. That is why advisers such as myself are here to assist and serve you as best we can. Even though the below mentioned tax breaks are ultimately claimed on your tax returns, year-round tax planning is important to fully maximize any tax benefits.
In general, these tax breaks are not specific to 2020, but available in any year. Under the tax code, self-employed individuals are treated like small business owners, so the rules apply uniformly.
#1: General rules. Businesses are generally allowed to deduct the costs of carrying on the trade or business. To be deductible, the Internal Revenue Code requires that business expenses be ordinary and necessary. “Ordinary” means the expense is common and accepted in an industry, while “necessary” means the expense is helpful and appropriate for the trade or business. Examples of allowable expenses are salaries paid to employees, rent expense for office space, travel expense for marketing, and interest paid on a company loan.
The personal portion of an expense is not deductible, such as personal use of a company automobile. The rules apply to small businesses regardless of the type of entity (sole proprietorship, partnership, corporation or S corporation).
#2: 20% Qualified Business Income (QBI) deduction. Under the tax reform (Tax Cuts and Jobs Act), there is the QBI 20% deduction on business income for small business owners who report their operations on Form 1040, including sole proprietors who use Schedule C (as well as income from partnerships, S corporations and limited liability companies).
This is a big windfall for small business owners because $20,000 of $100,000 of business income would go untaxed! This deduction allows small business owners to keep more earnings tax free, and helps curb high tax rates and the 15.3% self-employment tax. Small businesses qualifying for the 20% tax deduction could see their effective marginal tax rate reduced to 29.6%.
There are some calculations and limitations surrounding this deduction, including a phase out of the deduction for high-income earners (over $160,700 for single filers, $321,400 for joint filers).
#3: Home office deduction. If you use part of your home regularly and exclusively to perform administrative or managerial activities for your business, you can claim a home office deduction for utilities, rent, mortgage interest, depreciation and cleaning fees based on the square footage of the home used for the business. Any allowable home-related itemized deductions, such as mortgage interest and real estate taxes, can still be claimed.
The IRS also provides a simplified calculation for figuring the deduction for using a home for business. This simplifies the calculation and record keeping requirements, but does not change the criteria as to who may claim the deduction. A portion of the home must still be used exclusively, and on a regular basis, for business purposes. In general, figure the deduction by multiplying the area of a home used for business by $5, up to a maximum deduction of $1,500.
#4: Start-up costs. The government encourages people to open a new business by allowing a $5,000 write-off for start-up expenses. This $5,000 deduction is reduced by the amount that total start-up expenses exceed $50,000. Any start-up costs that are not allowed to be expensed can be amortized over a 15-year period, beginning in the month the client starts operating.
Start-up costs include amounts paid either to create a trade or business, or to investigate the creation or acquisition of a trade or business. Examples include ads for the opening of the business, as well as travel and other necessary costs for securing prospective distributors, suppliers or customers. Once the enterprise actually begins operations, all business expenses are deductible. This write-off is on the business tax return.
#5: Retirement plans. It’s always a good idea to plan for retirement, especially with some nice government incentives. There are a variety of retirement plans available to small businesses that allow the employer and employee a tax-favored way to save for retirement. Contributions made by owners for themselves and employees can be deducted.
There are lots of choices in retirement plans:
- IRAs, SEP IRAs and SIMPLE IRAs avoid the complex rules, red tape and expensive administration costs that apply to qualified retirement plans.
The small business owner is also allowed a tax credit equal to 50% of the first $1,000 incurred in starting a plan. It’s smart to consult with a financial planner before deciding on a plan that best suits the business’s needs.
#6: Depreciation. Business owners are allowed to fully write off the entire cost of new purchases (100% bonus depreciation), such as computers, furniture and equipment, in lieu of depreciating the cost of the asset over a number of years. Another huge bonus: Used property now qualifies.
Under a companion measure, the government increased the popular Section 179 tax break to $1,020,000, which represents the amount of assets clients can deduct in their first year.
These generous depreciation deductions allow the small business owner to increase their deductions, and thereby reduce their taxable income, self-employment income and tax liability.
#7: Meal expenses. Meal deductions can be taken either within the context of business travel, or if provided to a current or potential business customer. A taxpayer can deduct up to 50% of the meal expense as long as the food or beverages are not considered lavish or extravagant. For business meals, the meeting must include business either directly before, during or after the meal is consumed.
#8: Business travel. If traveling out of town for business (such as to the U.S.), the cost of getting to and from the destination, and any business-related expenses occurred at the destination, are deductible. To be allowable by the IRS, the travel expenses must be considered reasonable, and not lavish or extravagant.
Meals are deductible when away from a tax home in pursuit of the taxpayer’s trade, and the business trip is overnight or long enough that the person would need to stop for sleep or rest to properly perform their duties. Meal expenses must be reduced by 50% before being deducted, but lodging expenses are not reduced.
#9: Self-employment tax deduction. Where traditional employees have their FICA taxes split between themselves and their employers, self-employed individuals are responsible for paying their own share of Social Security and Medicare contributions. Self-employed individuals can claim a portion of the self-employment tax as a deduction (roughly 50%).
#10: Credit for research and development expenses. To qualify for this credit, the business must incur expenses for the purpose of discovering information that is technological in nature, and for the development of a new or improved business component. For example, a bakery that invests in developing machinery that automates the icing process may qualify. Ordinary testing and inspection; consumer, management and efficiency studies; and promotions do not count as research.
As discussed, there are a multitude of tax breaks available to small business owners to reduce the tax liability and keep more money in your pockets – to be rolled back into the business, saved for retirement or spent on personal items.
The US tax advisers at Grant Thornton Israel can assist in the planning and maintenance of your business tax plan. Please contact for an appointment or to discuss your business.