Tax Tips
Deductible Expenses for Small Businesses - Part I - March 2000
Richard Scrivanich - Partner
If you're not entirely clear on what constitutes a deductible business expense, you're not alone. Many business owners are unsure about what can and cannot be deducted. The more tax deductions your business can legitimately take, the lower its taxable profit will be. To use the IRS's terms, almost any "ordinary and necessary" expense that is "reasonable and customary" qualifies as a deductible business expense. The words reasonable and customary refer to your specific business and the business customs in your area. For example, if you're in the advertising business, you may be able to deduct just about every newspaper and magazine you buy, because an awareness of trends in advertising is central to your business. The same deduction would not be available to you if you have a catering business.
Current versus capital expenses.
Before discussing specific deductions, you need to know the difference between current expenses and capital expenses that must be depreciated. Current expenses, which include the everyday costs of keeping your business going-such as office supplies, rent, and electricity-can be deducted in the year you incur them. But expenditures for things that will generate revenue in future years-a desk, a copier machine, or a car, must be depreciated-that is, written off over its useful life. According to IRS rules, that period is usually three, five, or seven years.
There is an important exception to this rule-the expensing deduction, a special tax break for smaller businesses. Under Section 179 of the Tax Code, in 1999, you can immediately write off up to $19,000 in equipment purchases, rather than depreciating their cost over a period of years. In addition, the equipment purchases are eligible for a full write-off under the expensing method no matter how late in the year the purchases are made. If you charge the purchase on a credit card before the end of the year and do not get billed until January, you can still take the deduction in 1999, as long as you placed the asset in service before the end of the year.
Expensing gives you an immediate deduction, but there are a few rules you need to be aware of. The amount you can write off immediately is limited to the amount of taxable income you have from your business. So if your business income is meager, your expensing write-off will be meager, too. Special restrictions also apply to personal computers, cellular phones and certain other equipment. Generally, these items must be used more than 50% of the time for business in order to qualify for expensing.
As a general rule, it's a good idea to place new equipment into service before the end of the year, the reason being that, under the "mid-year convention," business assets placed in service during the latter half of the year are treated as if they had been placed in service on July 1 for purposes of computing depreciation deductions. In other words, you may be able to claim the equivalent of a half-year's worth of depreciation, even if you use the equipment only for a few days in December. However, a special tax rule is triggered if you place too much equipment in service at year-end. Specifically, if the cost of business assets placed in service during the last quarter of 1999 exceeds 40% of the cost of all business assets put in service during the year, your depreciation deductions for all assets placed in service during the year are figured under the mid-quarter convention, which will dramatically reduce your annual depreciation deduction.
Transportation expenses.
If you use your personal car for business, or your business owns its own vehicle, you can deduct some of the costs connected with keeping your car running. There are two methods of claiming automobile expenses. You can either keep track of and deduct all your actual business-related car expenses-that includes gas and oil, repairs and maintenance, depreciation, insurance, tires-or you can simply take the standard mileage rate. This rate is set by the IRS and is adjusted annually. For 1999, the standard mileage rate was lowered, effective April 1, to 31 cents for each business mile driven. If you're not sure which method to use, as a general rule, if you have a newer car and you use it primarily for business, the actual expense method is likely to provide a larger deduction.
What about business travel? When you travel for business, you can deduct many expenses, including the cost of plane-fare, taxis, lodging, meals, telephone calls, etc. Here's a little known bonus- if you extend your stay to take advantage of the "Saturday overnight requirement" for discounted airfare, your hotel room and meals would be deductible.
In next month's Tax Tips we'll continue our discussion of deductible expenses for small businesses by taking a look at bad debts and casualty losses, entertainment expenses, the home office deduction and miscellaneous expenses. However, in the meantime, if you have any tax related questions, please feel free to call me at (562) 698-9891.
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