By Stephanie Raimbert
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Most small business owners trying to save money should focus on tax deductions. Figuring out which business expenses you can deduct from your taxable income can save you money. This is why it's important for small businesses to consult accountants and other tax experts to ensure they are maximizing their financial options. Generally, taxes are a significant expense for most businesses. However, 2020 isn’t a normal year, and the new tax rules provide opportunities to get money back. Both Congress and the IRS have created new tax breaks to help small businesses cope with the economic fallout of COVID-19. Below are some key tax rule changes that may affect you and your business. You should understand these tax rule changes to save money on your taxes.
Small Business Tax Changes for 2020
According to Pitney Bowes, under tax-free income, if you receive a Paycheck Protection Program (PPP) loan, which is designed to help you keep or bring back employees onto your payroll, your debt can be forgiven up to set limits. Typically, the cancellation of debt triggers taxable income, but under a special rule for PPP loan forgiveness, it is tax free. If you received an Economic Impact Payment, it is tax free and did not have to be reported on your personal 2020 federal income tax return.
Under deferred taxes, you usually must deposit employment taxes—income tax withheld from paychecks plus the employer and employee share of Social Security and Medicare (FICA) taxes—on workers’ taxable compensation according to a set schedule. However, under a new rule, you can elect to defer the employer share of Social Security taxes from March 27, 2020, through the end of the year. If you make the election, then 50% of the deferred amount is payable by the end of 2021 and the other 50% is payable by the end of 2022. If you received a PPP loan, you must stop deferral once the loan is forgiven.
Under tax refunds, due to several law changes in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, you may be able to file amended returns for 2018 (and/or 2019 if you already filed this return) to obtain a tax refund. Here are some of the sources for refund opportunities (these law changes apply for 2020 as well):
· Net operating losses. If you suffered a net operating loss in 2018 (or 2019), you can carry back the loss for 5 years to offset all the taxable income in those years. The result is an immediate tax refund. The IRS has provided procedures to expedite these refund claims.
· Interest expense limitation. Businesses that do not qualify for a small business exemption based on the amount of average annual gross receipts (as well as larger farming and real estate businesses that didn’t elect exemption) are subject to a special limit on the amount of interest paid that can be deducted. The CARES Act liberalizes the rule to allow for a greater deduction, permitting amended returns that may produce tax refunds.
· Qualified improvement property. If you made certain improvements to the interior of commercial space, such as a restaurant or retail store, you can now treat the costs as fully deductible, using bonus depreciation in the year in which you placed the property in service. Previously, such costs had to be depreciated over 39 years. Again, the IRS has provided procedures to make this change in accounting method and obtain tax refunds.
Finally, tax credits are even better than tax deductions because they are a 100% offset against taxes. Typically, tax credits offset income taxes. But, new credits offset certain employment taxes.
· Employee retention credit. A qualified small business that pays qualified wages (amounts up to $10,000 per employee, plus health insurance coverage) after March 12, 2020, and before January 1, 2021, can take a 50% credit. The credit is refundable, so it can be recouped even if the amount of tax credits is more than taxes owed. A qualified small business is one where the business is partially or fully suspended because of COVID-19 or has gross receipts below 50% of the comparable quarter in 2019. The credit is an offset to all employment tax deposits and is calculated on a quarterly basis (starting with the second quarter of 2020). If employment taxes are not sufficient to cover the credit, the employer can receive an advance payment from the IRS. There’s a new tax form to obtain the advance payment of employer credits.
· Paid sick leave. Small businesses required by the Families First Coronavirus Response Act (FFCRA) to provide certain paid sick leave to employees up to 80 hours can take a fully refundable tax credit to offset the required payments (up to a set dollar amount). An advance payment similar to the treatment for the employee retention credit applies here.
· Paid family leave. Small businesses required by FFCRA to pay up to 10 weeks of family leave related to COVID-19 can also take a fully refundable tax credit. Again, an advance payment similar to the treatment for the employee retention credit applies here.
You can’t use the employee retention credit for the same wages subject to the paid leave credits. Since these rules are highly confusing, so it is advisable to work with a CPA or tax professional to make sure you are making the right choices of which tax breaks to use. Click here for more information on 2020 small business tax changes.
What are small business tax deductions?
Small business tax deductions are allowable expenses that you use to lower your business's taxable income, according to Business.com. These deductible business expenses are often referred to as tax write-offs. TheIRS taxes businesses on their net income, which subtracts your business expenses from your gross income. Operating expenses are often tax deductible, but it is important to note that some are not.
Many business expenses are deductible, but deductions for one industry may not be considered necessary expenses in another. It is far easier to speak about deductible expenses in terms of what is not deductible. One of the starting points for figuring out what is deductible is to determine what legal structure your business will operate under, according to Bret Scholl, a certified public accountant and chartered global management accountant at Scholl & Company LLP.
How do small businesses maximize tax deductions?
Most small businesses operate as a sole proprietorship, partnership or limited liability company (LLC). These entities are required to file a separate tax return unless the company operates as a single-member LLC. Small business tax deductions are reported on the business tax return, reducing the amount of taxes the business has to pay.
In 2018, the Tax Cuts and Jobs Act went into effect, granting pass-through entities (sole proprietorships, partnerships and S-corps) the ability to deduct 20% of their qualified business income. According to the IRS, to be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business, while a necessary expense is helpful and appropriate for your trade or business. If your business expenses align with IRS requirements, you can claim them on the business tax return and lower your business's taxable income.
Top small business tax deductions
According to Business.com, once you have chosen the best legal structure for your business, it is important to know what deductibles most businesses take advantage of. Here are some commonly deducted businesses expenses, according to Jessica Smith, an enrolled agent at Slate Law Group.
Home office: If you use a portion of your home exclusively and regularly for business, you can deduct certain expenses for the business use of your home. These expenses may include rent or mortgage interest, insurance, utilities, repairs, and depreciation. You must know the square footage of the space that you use exclusively and regularly for business as well as the total square footage of your home to calculate the office deduction.
Startup costs: If you paid expenses related to the creation of an active trade or business, you can deduct up to $5,000 in startup costs for your first year of business. Startup costs include advertising, employee training, supplies, and other expenses you paid in the process of creating a new active trade or business. This deduction is limited in the event that you paid more than $5,000 in startup costs. Costs over this threshold must be capitalized over a 15-year period.
Organizational costs: The same rules used to determine the deduction for startup costs can be used to deduct up to $5,000 in organizational costs in your first year of business. This amount is in addition to the $5,000 deduction available for startup costs. Organizational costs include the expenses of forming your business structure, such as fees for forming a legal entity.
Interest: If you borrowed money to cover your startup costs and/or to operate your business, the interest you paid is deductible.
Vehicle reimbursements: You can cover a portion of the expenses you or a spouse or family member incur while running errands for your business (e.g., making a deposit or picking up supplies).
Child wage deductions: The owner of a non-incorporated business can hire their children (under 18 years old) and reduce their tax liability. For example, a sole proprietor making $125,000 annually who pays their 16-year-old daughter $10,000 could save $4,000 or more in federal taxes.
Qualified retirement contributions: As a small business owner, you can deduct contributions to your Simplified Employee Pension (SEP) IRA. Certain rules and conditions apply. It is recommended that you work with a CPA if this is a deduction you want to take advantage of.
Medical expenses: In limited cases, you can deduct medical expenses from your business income. If you are a sole proprietor and you buy your own health insurance, you can deduct the amount of money you spent on premiums.
Salaries and wages: If your business operates as an LLC, you may not be able to deduct income you take from your business. However, the salaries and wages you pay to your employees are deductible.
Work opportunity tax credit: The federal work opportunity tax credit is available to employers for hiring target groups that have faced barriers to employment, such as ex-felons, qualified veterans and Supplemental Security Income (SSI) recipients.
Office supplies and expenses: This office deduction covers small business expenses ranging from desks and chairs to paper and ink. Even if your business does not have a traditional office space, you can still deduct office supplies and expenses so long as the supplies are used within the year of purchase. In many cases, you can deduct the cost of postage, shipping and delivery services as well.
Contract labor: Many small businesses use freelancers, independent contractors and self-employed individuals to support their workforce. The cost of this contract labor is deductible. Form 1099-MISC is an IRS form that taxpayers use to report non-employee compensation. The form is also used to report miscellaneous compensation, such as prizes, awards, healthcare payments and attorney fees.
Taxes: You can deduct numerous taxes and licenses related to your small business. Here are some examples:
Business licenses
Fuel taxes
Sales tax
Real estate taxes paid on business property
Payroll taxes
Personal property taxes
State income taxes
Final Thoughts
It is best to consult a financial advisor to help you determine what you qualify for since there are rules and exceptions for all of these deductions. You need to understand the tax implications of your business's legal structure, maintain accurate records of your expenses and deductions, and partner with a tax expert who understands your business and industry to save the most money on business taxes. Good luck!
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