What are business tax deductions?
Business tax deductions are any ordinary and necessary expenses for your business operations in a given tax year. The expenses must be reasonable, necessary for conducting your business, and directly traceable to your business. Most of them are expenses that you have as a self-employed person or sole proprietor that you would not have if you were an employee, but most of these are also applicable if you have an LLC or S corporation established. If you are self-employed or a sole proprietor, you will use schedule C of IRS Form 1040, Profit or Loss from Business to calculate the net profit or loss from business. A schedule C must be completed for each business. It is on schedule C that a sole proprietor will take business expense deduction. For a corporate entity, these same expenses would be listed on Form 1120, which is the corporate equivalent of Form 1040 for individuals. Regardless of business structure, these deductions are the most common business deductions for 2022.
Whether you are preparing your quarterly estimated tax payments or preparing your year-end tax return, these common deductions will be items to consider when estimating your taxable income for the year.
Tax-wise, 2022 is going to look a lot like 2021. The Tax Cuts and Jobs Act (TCJA) has not been repealed, so that guidance is still in place. New items include a cap on the amount of net operation loss (NOL) for noncorporate businesses that you are allowed as a business deduction on your tax return. The new guidance on excess business losses states that you are only able to claim $262,000 (or $524,000 for married filing jointly) of net operating loss as a deduction on your tax return. Any amount above that must be treated as a net operation loss carryover for the next year. If you have other W-2 income in addition to your business losses, that amount is still included in taxable income. A CPA can help you to navigate which amounts are deductible and which are taxable.
Mileage increase – Beginning July 1, 2022, there will be an additional 2.5 cents per mile increase above the January 1 standard mileage rate. This will bring the mileage rate for the second half of 2022 to 62.5 cents per mile. This highly unusual mid-year increase is the IRS’s way to help compensate business owners for the above-average rise in gas prices.
Decrease in deductible interest on business loans – The TCJA placed a limit on the amount of interest payments that you can deduct as an expense from your taxable income. If all the conditions are met for deductible interest, only 30% of total interest is deductible.
If you just started a new business in 2022, you may have high startup costs such as equipment purchases, office space, marketing, and training or education. If these costs were incurred before you actually began business operations, they would not be deductible as regular business expenses since they did not occur in the course of your business operations. However, the IRS allows a startup cost deduction of up to $5,000 for these costs, since they are still necessary to your business though they were not incurred during business operation.
If you purchase tangible assets, such as business equipment, this cost will usually need to be depreciated over the life of the asset rather than deducted all at once.
All business travel costs incurred in the ordinary course of business are 100% tax-deductible. Business travel includes travel to conferences, travel to meet with clients, delivery or courier services, and any other travel that can be proved to be for business purposes. The deductible expenses include mileage costs, either actual or calculated using the standard mileage rate, taxi or Uber fees, plane or bus tickets, and lodging costs. Meals receive their own category, and not all business meal costs are deductible.
It is important to provide documentation that your trip was truly mainly for business purposes. If more than half of the time on the trip was spent on non-business activities, it is considered a vacation, and generally none of the costs are deductible.
More and more people are choosing to work from home or start a home-based business. The home office deduction allows you to deduct a portion of your home expenses as business deductions. In order to take this deduction, you must have a dedicated area in your home, whether it is a room or part of a room, which is exclusively for business purposes. If you have specific desk space for your business or an entire room for a home office, this area of your home is deductible. However, if you do your work at the kitchen table, this area is not deductible since it is not exclusive to business use. The ratio of business square feet to total square footage in your home is the percentage of your home’s expenses, such as homeowner’s insurance, electricity, and internet, which are deductible. For the tax years 2018 through 2025, the TCJA temporarily eliminates the deduction for miscellaneous itemized deductions subject to the 2% of AGI limitation. This category of deductions includes employee business expenses, such as the home office deduction. Businesses that use schedule C to report business income will take home office expense deduction on the schedule.
If you are self-employed or a contractor, you are responsible for the full amount of your health insurance and retirement costs. The portion of retirement contributions and health insurance premiums that would be paid by an employer are deductible as business expenses for self-employed persons.
Section 179 depreciation helps businesses front-load their expenses to decrease taxable income. If you bought equipment for your business and put it into service this year, and if your business is profitable, you may elect to take section 179 depreciation to decrease your taxable income. The section 179 depreciation deduction limit is $1,080,000 for 2022. Because of changes to section 179 depreciation by the TCJA, it is best to consult with an accountant to decide how to allocate your expenses to regular, bonus, and section 179 depreciation.
The TCJA limits net operating loss deductions in a single tax year to 80% of the net loss, with no carry back and infinite carryforward. So long as the TCJA remains in effect, this is the guidance.
The qualified business income deduction, which allows small business owners to deduct up to 20% of their qualified business income, 20% of their qualified REIT income and qualified publicly traded partnership (PTP) income from their taxes. This only applies to sole proprietors, partnerships, S corporation owners, and select trusts and estates. C corporations are not eligible. The deduction for 199A is claimed on Form 1040 as an adjustment to Gross Income, not on Schedule C.
The IRS allows a certain amount of interest payments for business loans to be deductible under certain circumstances. In order for business interest to be deductible, it has to meet the following criteria:
- The loan must be through a business lender (not friends and family loans)
- You must actually spend the money for your business, and it is not just sitting in a bank account
The nice thing about business interest payments is that it does not just apply to standard term loans but can also apply to interest paid on business lines of credit, and to any business portion of personal loans (ex. If you have a loan on a car that you use for both personal and business purposes).
Whether you have employees, hire out to a subcontractor, or find a freelancer on an online marketplace, any compensation, including vacation pay and bonuses, paid to those persons is fully deductible so long as the following conditions are met:
- All work paid for is satisfactorily completed
- All payments occurred in the year you are claiming the deduction
- The compensation was reasonable for the work completed.
The IRS usually does not audit or challenge wages expense, but if you have a person listed as an employee who is an investor or family member, the IRS may be inclined to look more closely, so have documentation ready.
All legal fees incurred in the course of business are deductible. This could be simple items such as a business license or a DBA filing fee. Larger items such as consultation with a lawyer or accountant are also included in this category, and costs of incorporation, annual report filing fees, and tax filing expenses are also deductible.
Hopefully, you will never find yourself and your business in the unfortunate situation of losing a legal suit, but if you should, your legal expenses are deductible even in the event that you lose your case.
To determine if your business is a hobby, the IRS looks at numerous factors, including time spent and effort to make a profit. An activity is presumed to be carried on for profit if it makes profit during at least three of the last five tax years, including the current year. If these criteria are not met and your activity is turning losses, it will be deemed a hobby and you will not be able to take deductions.
All of these expenses and more will find your way onto your tax return, and whether you keep records yourself or outsource it to a bookkeeper or accountant, maintaining clear and accurate records of each deduction is crucial to tax success. Some expenses are more likely than others to be audited – employee compensation is not likely to be questioned, but unusually large bonus depreciation purchases may raise doubts about whether the item is truly ordinary and necessary. If you should have expenses like this in 2022, be sure to provide good records, both of the purchase itself and how it is used in your business operations.
Tax deductions are always changing, and an expert accountant can help you keep up with the latest guidance. If your business is growing in 2022, it is a good time to consider outsourcing your tax preparation, quarterly estimated tax payments, and tax guidance to a professional. Shah CPA is available for initial consultations, expert tax guidance, and a full list of business advisory services. Contact us for a free consultation.