There are a several variations of the same question accountants hear from small business clients every tax season; “What do you mean I owe the government money?” Which is usually followed by; “I had more expenses than that!” Accountants are then forced to explain to clients that their hands are tied and they cannot manufacture expenses out of thin air and spontaneously create deductions on behalf of clients. To be certain that your accountant does the best possible job of minimizing your tax bill is to provide the information they need.
The IRS defines a deductible business expense as one that is “both ordinary and necessary”. For most people that term refers to both nothing and everything. The IRS, however, says that an ordinary expense is one that is commonly accepted for your type of business. For example, wood and nails are ordinary expenses for a carpenter, but not a taxi driver. Necessary expenses are those that you cannot do without. For example, gasoline is a necessary expense for a taxi driver, but not for an accountant.
Record Keeping and Supporting Documents
Whether you use bookkeeping and accounting software or a paper ledger system such as a Dome Book, you should record purchases, sales, and expenses including payroll and other transactions. The IRS suggests that you retain accounting records for seven years and will only ask to “examine” your books if you are audited. Supporting documents, such as receipts should also be kept for seven years and scans of originals are considered acceptable by the IRS.
Cost of Goods Sold
If you are in the business of making goods for resale you are allowed to deduct the cost of the materials needed to manufacture your products. If you are in the business of selling already manufactured products you will have to supply your accountant with the value of your inventory at the start of the year and its value at the end of the year so that he will be able to calculate your gross profit. You cannot double dip by including expenses as part of the cost of goods sold as well as business expenses.
Business Use of Your Home – Popularly known as the home office expense and it allows you to deduct a portion of “certain expenses” related to your home such as; mortgage interest, insurance, utilities, repairs and depreciation. The rules concerning this deduction are very strict and you should consult your accountant before assuming you can deduct them.
Business Use of Your Car – You are allowed to deduct either actual expenses or a per mile amount ($.56 for 2014) if you use your car for your business. You should keep a log of where you drive for business, including dates and mileages. A log is especially important if you use your car for both business and personal use.
Employee Pay – The amount you pay your employees is deductible from your business income as an expense.
Rent – You may deduct any rents you pay for property used to conduct your business. You may not deduct rent if you own the property you are using.
Taxes – Taxes you pay to federal, state, municipal and foreign governments that are directly related to your business are deductible.
Retirement Plans – Contributions you make to both your own and your employees’ retirement plans are deductible.
This is not a complete list and some other deductions may be available that are specific to your industry. Certain tax deductions and tax credits may not be available every year, which is why it is always a best practice to consult with a qualified tax professional like a CPA to make sure you are maximizing your deductions.