One of the most frequent questions business owners ask is which business expenses they can deduct to reduce their taxable income. If you are a US taxpayer with a business, either in the US or abroad, you can deduct a variety of expenses, but you need to identify and track them properly.
To learn more about business taxation in general, check our out Business Tax Guide For Expats.
In this post, we cover the following:
- Which Expenses Are Tax-Deductible?
- Advertising And Marketing Expenses
- Payments To Contractors, Salaries, Professional Services
- Taxes And License Expenses
- Office Expenses
- Vehicle Expenses
- Depreciation Of Equipment Or Property
- Travel And Meals
- Other Common Business Expenses
- Business Expenses Vs Cost Of Goods Sold
- How To Claim Business Expenses Correctly On Your Tax Return
- More Ways To Save Taxes With Business Expenses For S Corporations
Let’s get started.
Which Expenses Are Tax-Deductible?
The IRS has a business expense publication (Publication 535) that states that in order to be deductible, a business expense must be both ordinary and necessary.
What does this mean?
It must be a common, reasonable, and accepted expense in your industry that helps to run or improve your business.
These are the most common business expenses:
- Advertising and marketing
- Payments to contractors, salaries and professional services
- Taxes and licenses
- Office expenses and utilities
- Vehicle expenses
- Travel and meals
- Depreciation of equipment and property
- Other expenses
Let’s explore these potential deductions in more detail.
Advertising And Marketing Expenses
Advertising and marketing refer to the costs your business incurs for promoting its goods, services, or brand.
Some qualifying expenses include business cards, advertising in print or digital media, promotional events, and email newsletters. You can also deduct cost for SEO services or the design of marketing material.
Payments To Contractors, Salaries, Professional Services
You can deduct from your business income the payments for people you hire for the business. This applies to:
- Independent professional services, e.g., bookkeeper, lawyer, tax accountant
- Independent contractors, e.g., content writer, sales person, web developer
- Employees, full-time or part-time
The IRS clearly differentiates between employees and contractors. Employees are on the business payroll and receive benefits. The employer controls how the employee performs the work. US employees receive a W-2 tax form from the employer.
On the other hand, independent contractors control themselves how they do the work. The paying business is the client of the contractor. It can only control the result of the contractor’s work.
A US business issues a 1099-NEC form to US contractors for professional services if they pay $600 or more during the year for provided services.
Professional fees include typically include services needed for operating your business that you don’t have inhouse. Tax tip: Hiring a tax professional to prepare your business tax forms is a deductible expense.
Taxes And License Expenses
Some taxes and license expenses you can deduct are
- Sales taxes imposed on you as the seller of goods or services
- Real estate and personal property taxes on business assets
- Yearly paid licenses and regulatory fees for your business.
- Social security and Medicare taxes paid to match employee withholdings
It can sometimes be confusing, which office expenses you can deduct from your business income, as many work from home.
When you own or rent a separate space as an office, all the expenses are directly connected to the business. However, if the office is located in your home, the expenses paid for the entire property will be indirect expenses.
A home office is a space in your home that you use exclusively and regularly for conducting business. (Hence, your kitchen table wouldn’t count.)
How to determine the percentage of your home used exclusively and regularly for conducting business?
You live in a 1000 sq ft home and devote 400 sq ft to your business activities. You can consider for deductions 40% of indirect expenses such as mortgage interest or rent, property insurance, utilities, and depreciation.
Office expense deduction show how important it is to keep track of which expenses are directly or indirectly related to your business.
US persons living abroad who qualify for foreign earned income exclusion may be able to exclude the portion of rent and utilities considered as personal use through the foreign housing exclusion. But they cannot use the foreign housing exclusion to exclude the home office space, and then deduct it again as office expense. No double dipping!
Mortgage interest paid for other business properties to a bank or other financial institution is also a deductible expense.
The IRS provides two different methods to calculate vehicle expenses deduction:
- The standard mileage rate method, or
- The actual expense method.
You may qualify for one or both options.
Standard Mileage Rate Method
This method allows you to deduct a fixed amount (updated every year) per mile driven for business purposes.
To use this method, you must choose to use it in the first year the car is available for use in your business. Then, in later years, you can choose to use either the standard mileage rate or actual expenses.
Actual Expense Method
This method requires you keep track of all the expenses you incurred and of the total miles driven both for business use and personal use, if any.
Similar to home office expenses, you determine your vehicle’s percentage of business use and calculate the expenses allocated to it.
Actual expenses can include:
- Lease payment
- Registration fees
- Parking and garage fees
If you don’t own a vehicle and use Uber or other rideshare apps to go to your office (or co-working space) or to business meetings, you can deduct those expenses. Make sure you pay and track them separately from your personal trips.
Depreciation Of Equipment Or Property
The purchase of assets such as computer equipment, vehicles, machinery, or real estate properties is not a direct expense that you can deduct. But you can take advantage of time and depreciation expense.
To calculate the depreciation, you will need to state the date the asset was placed in service and the value. Each type of asset has a different expected life and method to use for the calculation.
When selling an asset used to generate income, you must use the depreciated value of the asset as the cost-basis even if you did not claim a depreciation deduction. Then, why not use it to reduce your income?
Travel And Meals
Tracking and determining deduction eligibility of travel and meals expenses can be a headache for anyone. As mentioned at the beginning, business expenses must be ordinary and necessary, and can’t be for personal purposes.
Business travel means from and to your place of business. This makes it murky for digital nomads, as they usually don’t have a fixed place of business. Let’s say you run your online business for 1 month from Medellin, Colombia. Then you move on to Buenos Aires, Argentina, and work from there. The travel from Medellin to Buenos Aires does not count as a business travel expense.
Almost every person travelling away from their home for a business trip incurs in some personal expenses such as visiting museums during their free time or taking some extra days for vacation.
Therefore, you must allocate your travel time and expenses on a day-to-day basis between business days and nonbusiness days. It is important to keep good records and a detailed calendar for when tax season arrives. The IRS provides additional rules and some exceptions on Publication 463.
Actual travel and meal expenses includes costs such as:
- Airfare or train tickets
- Taxi or rideshare fare (Uber, etc)
- Public transportation
- Business and non-entertainment related meals
- Business calls
- And more.
For the period between January 1, 2021, and December 31, 2022, you may be able to deduct 100% of your meal expenses. Otherwise these expenses are limited.
Per Diem vs Actual Expenses
There is a simplified method for travel deductions that allows you to claim a standard allowance instead of actual expenses. This is called per diem.
Per diem rates are fixed location-specific amounts to compensate for travel expenses such as accommodation, meals, and incidental expenses. You can find when per diem deduction is convenient and how to use it in our prior article Should International Business Travelers Use Per Diem Travel Expenses?
Other Common Business Expenses
You may incur other expenses while running your business that can reduce your taxable income. To name a few:
- Training and education
- Rent of equipment, machinery or other business property
- Software purchase or subscription
- Internet and web housing
- Insurance premiums (other than health)
The list can go on. If the business expense is both ordinary and necessary, it is worth to analyze whether it is deductible or not.
Business Expenses Vs Cost Of Goods Sold
In case your business manufactures products or purchases them for resale, it is important not to mistake cost of goods sold with business expenses.
Cost of goods sold (COGS) includes inventory already owned, cost of labor, materials and supplies. Deduct this from your gross receipts to calculate the gross profit of your business.
The key is to never include an expense both in the cost of goods sold and in the business expense section.
How To Claim Business Expenses Correctly On Your Tax Return
Organized records make it easier to prepare a tax return. Keeping records, such as receipts, canceled checks, and other documents that support a deduction is vital. If possible, avoid co-mingling business and personal expenses. Do not use your business credit card for purely personal expenses.
Consider having a bookkeeper (which is a deductible expense), or at least use a bookkeeping software.
More Ways To Save Taxes With Business Expenses For S Corporations
As a business owner that draws a salary from the business, be aware of how expense reimbursements are taxed. When you reimburse yourself for a business expense, the reimbursement is added to your taxable income and reported on your W-2.
As an S Corporation owner, you can tax-optimize your business expenses by using an Accountable Plan. With an accountable plan, an advance or reimbursement of a qualifying business is not reported as wages.
Finding a US tax expert who truly understands your business situation, optimizes the deductions, and does the math for you makes the difference.
For more information to optimize your tax situation, schedule a consultation with our accountants.