What Is the Difference Between a Deduction and Capitalization?
While there are many things that aren’t tax-deductible, there are things that you can instead capitalize. If a business capitalizes a cost, it puts off recognizing it as an expense.
Example: If your business buys $15,000 worth of inventory to sell, you would initially write it down as a capitalized cost. Once you sell that inventory, you can write it off as an expense.
Disclaimer: This information is meant for educational purposes only and not to be treated as legal or financial advice. Please consult a professional with any questions or for consultation.
- Office supplies: You can deduct any supplies that are consumed during the duration of the tax year. This includes stationery, pens, pencils, paper, paper clips, binders, etc.
- Business phone: If you operate out of a home office, you cannot deduct basic telephone line expenses. However, business long-distance phone calls and separate business lines are considered deductible business expenses.
- Furniture and equipment rental
- Office security systems
- Specialty clothing: If an item is not typical attire for personal daily use, it is deductible. This could include uniforms for a nurse or police officer, or steel-toed boots for a construction worker.
Any services that are necessary to keep your place of business running smoothly are fully tax-deductible. Some of these services include:
- Printing services
- Accounting services
- Postage, delivery and freight
- Cleaning services
- Bank charges
Reasonable advertising expenses are considered deductible as long as they are related to your business. You cannot, for example, deduct expenses that go toward political matters (e.g. lobbying).
Rent and Maintenance
You can deduct rent expenses as long as they are reasonable. An example of unreasonable rent is an amount that is different from the average rent payment (e.g. a discounted rate between relatives). Otherwise, any rent that comes from property used for your business is deductible.
Any repairs or maintenance that are routine and do not add value to the property are also deductible expenses. This can include repainting, reconditioning, and any other repairs that do not involve replacements. Any replacements (e.g. flooring, plumbing, roofing) must be capitalized.
Utilities such as heat, electricity, water, and sewage are deductible business expenses. However, personal use of these utilities are not deductible.
Any interest accumulated from business-related debts during the tax year are considered deductible expenses. However, interest that comes from your business producing physical property has to be capitalized.
Any premiums you pay that are related to the operation of your business are deductible. Some common forms of necessary business insurance include:
- Credit Insurance
- Malpractice Insurance
- Liability Insurance
- Workers’ Compensation
- State Unemployment Insurance
- Automobile Insurance: If you use a business vehicle for occasional personal purposes, you must deduct only the part of the premium that applies to business use.
- Self-Employed Health Insurance: This insurance must be established under the business name or a member's name.
You cannot deduct premiums on insurance related to loss of earnings, life insurance in which you or another member are a beneficiary, and loan protection insurance.
Licenses and Permits
Any licenses and permits granted by federal, state, or local governments are typically deductible. Some licenses, like liquor and broadcasting licenses, have to be amortized. This just means that the business has to gradually write off the initial cost of getting and maintaining specific licenses and permits.
The IRS states that employee pay is a deductible expense if it is reasonable and for performed services. Bonuses, benefit programs, and training expenses are deductible.
Any expenses related to training and educating your employees are also deductible. You can also deduct expenses related to your own education as long as you can prove that said education directly improves your work-related skill sets.
The most common home office deductions are mortgage interest, real estate taxes, home insurance, rent, repairs, cleaning expenses, electric, gas for home heating, internet, and telephone services.
The amount that can be deducted depends on the percentage an individual uses within the dedicated office space, meaning that room can have no other use other than for business. The percentage is calculated as the area of the dedicated office divided by the total area of the living space of the home.
If this calculation is too complex, an individual can also elect the simplified method and deduct $5 per square foot of the dedicated office space.
Vehicles that you use solely for business purposes are fully deductible. If you split a vehicle between personal and professional use, you can only deduct the mileage used for your business.
There are two ways you can figure out your actual vehicle deductions. The first option is to use the standard mileage rate put forth by the IRS, which is 58 cents for every mile used for business transportation.
Another option is to figure your deductions by calculating the actual costs of your car expenses. This could include gas, oil, tires, repairs, insurance, and registration fees.
There are three levels of tax: federal, state, and local. For example, some kinds of taxes can be deducted on a federal level, but not on a state level (and vice versa).
- Income: You cannot deduct federal or state taxes. Multi-member LLCs can deduct state and local income taxes as a business expense, but single-member LLCs can only deduct these taxes as an itemized deduction on Schedule A (Form 1040).
- Employment: You must withhold certain taxes from an employee’s paycheck (Social Security, Medicare, etc.), which are then sent to their respective levels of government. You can only deduct those employment taxes that you pay from your own funds.
- Self-Employment: Up to one-half of your self-employment taxes can be deducted.
- Sales: Sales tax that your business pays toward a product is considered part of the cost of the product, and is deductible if that product falls under a deductible category. You cannot deduct the sales tax paid for by consumers.
- Excise: All excise taxes that are considered ordinary and necessary are deductible.
Travel, Meals, and Activities
A “necessary and ordinary” expense isn’t always a required expense; sometimes these expenses are helpful for maintaining your business. These “non-required” expenses can fall under an entertainment umbrella:
- Gifts: Should your business decide to give gifts to employees or clients, the gift needs to be under $25 per person to be tax deductible.
- Meals: Any food or beverage provided for customers and employees (e.g. coffee, snacks) are 100% deductible. Employee meals and meals purchased during business travel are 50% deductible. Department of Transportation workers’ meals are 80% deductible.
- Travel: Most expenses are deductible as long as they are incurred for work-related travel. Hotel, airfare, rental cars, taxis, and train fees are deductible as long are they are for work-related travel. Frequently forgotten travel expenses can include baggage fees, laundry, telephone service, internet, and tips.
- Activities: Business holiday parties, employee birthdays, and anniversaries are 100% deductible.