We all want to deduct as much as possible from our taxes, right? It gives us that extra spending cash at the end of the year and minimizes how much we pay in taxes. To do this, though, you need to prove that your expenses are legitimate business expenses.
Knowing how to deduct the right expenses on taxes can be confusing, which is why many people choose to hire a professional to do it for them. However, if you're feeling a little more adventurous, there is a lot that you can do on your own — especially when it comes to business expenses.
Knowing how to calculate business expenses on taxes is essential when filing income tax forms. So let's dive in and take a look at what a good rule of thumb is so you can have an easier time.
Take Note of What's Ordinary and Necessary
Deduct expenses that are both ordinary and necessary to run your business. Expenses must be both common and accepted in the area where you conduct business. Anything that cannot be considered necessary for you to operate your business should not be deducted.
Additionally, the expenses should be reasonable, as creating a sizable deduction by taking lavish business trips or spending too much on office supplies would raise red flags for the IRS. As long as your expense deductions are both necessary and ordinary, you will be able to accurately document your deductions when filing taxes.
Make Sure It's Directly Related
Business expenses should help to increase turnover, generate profits, or keep the company running, and all of them should be documented and accounted for. Businesses must be able to provide evidence that the expense was not only necessary but also beneficial to the organization.
This documentation is essential, as it can greatly reduce the risk of being audited. Know how to identify business vs personal expenses. All business owners must ensure that any expense which can be classified as a personal expense cannot be claimed as a business expense and must be accounted for separately in their taxes.
Make Sure It's a Reasonable Amount
This means being mindful of any large purchases and making sure that you are not overpaying for products or services. Additionally, make sure you are aware of any tax deductions and credits that can help you reduce your taxable income.
Consider using tax software for additional guidance and assistance with filing correctly. Overall, the primary goal when it comes to business expenses and taxes is to make sure you are staying within an acceptable limit to avoid any penalties or fees.
Be Specific With Your Documentation
It is important to be specific with your documentation when filing to maximize deductions and credit. Keep detailed and organized receipts, invoices, and other documents for your business expenses. This is in addition to recording them on your taxes.
This will help you ensure accuracy while filing. It will aid in the case of an audit. Keeping organized records can help ensure you do not miss any deductions or credits available to you.
Don't Forget Employee Compensation
Business expenses related to employee compensation are usually deductible from a company's taxes. This includes things like:
- health care expenses
- vacation pay
- other remuneration
It is important to make sure that the expenses are only for the benefit of the employee and were paid in the same tax year as the deduction was claimed. Make sure that all wages and benefits are paid appropriately and on time.
Tracking information should be kept for every employee, such as a ledger showing all payments made and any documents and agreements related to the employee's compensation package. The company should also ensure that all necessary taxes are paid promptly. Failing to document and pay employee compensation can result in hefty fines from the Internal Revenue Service.
Travel and Entertainment Should Be Business Related
Specifically, when it comes to travel and entertainment expenses, one should make sure the expense directly relates to a bona fide business purpose. Expenses should be documented with an itemized list, receipts, and an explanation of the purpose of the expense.
Generally, it is a good idea to pay for travel and entertainment expenses with a business credit card for accounting purposes. Ultimately, it is important to understand the IRS regulations to accurately know what can be deducted.
Include Home Office Expenses
One of those considered deductible is the home office expenses. This applies mainly to people who work from home as a sole proprietor or as an independent contractor. Include home office expenses when filing taxes if the office space is used regularly and exclusively for business activity, or if the office space is part of the business's inventory.
An important consideration for home office expenses is that they must be reasonable. Additionally, different types of businesses have different requirements for what is considered a reasonable home office expense. It is important to research rules and regulations for your type of business as well as what qualifies as an acceptable home office expense.
Include Professional Services
Keep in mind that expenses for professional services such as accounting, legal fees, consultants, and more are deductible. To qualify for a deduction, these expenses must be necessary and reasonable, and they must have been incurred in the ordinary course of business.
As such, it is important to keep receipts and records of all invoices to minimize any tax burden or possible audit. It is also important to make sure that all services are billed for, and that they are reasonable in comparison to services offered in the industry.
Despite the additional paperwork, these deductions can result in significant savings on business taxes. To qualify for further deductions, read strategies here.
Understand the Rules on Business Expenses on Taxes
In conclusion, it's important to properly document and track your business expenses on taxes. A good rule of thumb when it comes to filing taxes for businesses is to keep all records of expenses for up to three years for tax purposes.
This will help save you money and keep you compliant with tax laws. Contact a qualified accountant today to help you with this process.
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