Starting a Business Can Help Lower Your Taxes

Becoming a small business owner could lower your family’s taxes, even if your new business is not yet profitable.

Because a business can claim tax deductions for its share of housing, utilities, transportation, travel, and computer equipment, starting a small business can legally save you thousands of dollars in taxes on your (and your spouse’s) full-time job income.

To learn more, check out our list of tax-deductible startup costs.

The government wants to stimulate the U.S. economy, so they generously give tax deductions for business startup costs and operating expenses.

Keep reading to learn about the IRS regulations regarding home businesses, side hustle gigs, part-time businesses that are allowed tax write-offs, and cautions on how to prove that your business is not merely a hobby (for which deductions are not allowed).

Understanding Tax Deductions

Tax deductions are expenses that can be subtracted from a business’s taxable income to reduce its tax liability. These deductions can be categorized into business expenses, home office expenses, and personal deductions. Understanding tax deductions is crucial for small business owners to minimize their tax bill and maximize their tax savings. By claiming the right combination of deductions, small businesses can lower their taxable income.

Benefits of Business Tax Deductions

Business tax deductions offer numerous benefits to small business owners. By claiming deductions, businesses can reduce their taxable income, lower their tax liability, and increase their cash flow. This can help businesses to invest in growth, hire new employees, and expand their operations. Additionally, tax deductions can help businesses to reduce their tax bill, which can be a significant expense for small businesses. By taking advantage of tax deductions, small businesses can save thousands of dollars in taxes, which can be reinvested in the business.

Expenses That Qualify as Tax Deductions for Starting a Business

There are two types of expenses that you can deduct from your taxes — start up costs and ongoing operating expenses.

Startup Costs

The IRS allows three types of startup costs eligible for deductible business expenses. You can only write them off on your taxes if you actually open the business.

Creation – Costs for research, competitor analysis, surveying markets, and visiting possible business locations. These costs can be associated with creating a new company or investigating an existing business for investment consideration.
Preparation – Costs for opening your company, such as buying equipment, employee training, travel to suppliers, advertising and marketing expenses, business cards, and legal fees.
Organizational – Expenses for incorporating your company, registering trademarks, salaries for company directors, and accounting fees.

The IRS allows you to deduct up to $5,000 in business startup costs and $5,000 in organizational costs totaling $10,000 BUT only if your total startup costs are $50,000 or less.

If your startup costs are over $50,000, you’re not allowed these deductions. These monies can be applied to reduce your taxes in the year before you open your business in the following year.

Need help calculating your startup costs? Learn how to estimate your startup costs by industry.

Business Operational Expenses

Once your business is open for customers, your list of tax deductions expands dramatically to include these expenses:

Car Transportation – You can deduct a portion of your car expenses (including gas and oil) when you use your vehicle for business purposes such as traveling to customers, suppliers, trade shows, and delivering merchandise.
Housing – If you have space in your home that is dedicated exclusively to your business, you can deduct the business’s proportional costs of that space (including mortgage, insurance, and property taxes) from your taxes.
Utilities – Dedicated phone lines for businesses are legal deductions, as are a portion of the costs to heat and cool your home business.
Travel and Entertainment – If you travel to trade shows, customer presentations, and suppliers, your travel expenses can also be used as tax write-offs.
Eating Out – If you hold business meetings over dinner, coffee, or even smoothies, you can deduct 50% of the cost of restaurant meals.
Computer Equipment and Furnishings – Section 179 of the tax code allows up to 100% of computer equipment to be expensed annually, up to six figures. This is good news since it means that your new computer can be deducted in the same tax year.
Computer Software – Programs you purchase to facilitate your business operations, whether they’re a single download or a subscription service, can be deducted on your taxes.
Office Supplies – Supplies you use regularly, like shipping boxes and packing peanuts or printer paper and toner, can qualify as deductible expenses, provided they’re used solely for your business.
Health Insurance Premiums – Premiums for health insurance can be deducted, providing significant tax savings for business owners.
Education – Any education that will help in your business can be expensed, from training on how to use Photoshop to classes on bookkeeping.
Legal and Accounting Fees – The fees you pay your attorney or accountant, whether they’re a one-off service or a regular part of your business operations, are deductible business expenses.

Maximizing Tax Deductions

To maximize tax deductions, small business owners should keep accurate records of their business income and expenses throughout the year. This includes receipts, invoices, and bank statements. By keeping accurate records, businesses can help ensure that they are claiming all eligible deductions and minimizing their tax liability.

Additionally, businesses should consult with a tax professional to help check that they are taking advantage of all available deductions. A tax professional can help businesses to identify eligible deductions, prepare tax returns, and navigate the nuances of the tax code.

Best Businesses to Start Today

Consulting – This can be home-based, where you travel to your customers or consult via telephone and Internet. Usually, you can deduct costs for home office space, telephone lines, internet access fees, and computer equipment. Consulting businesses can also take advantage of various small business tax deductions to reduce their taxable income. For more information, check out “Reasons To Start a Consulting Business.”
Internet Services – This category can include website designers, coders, programmers, e-commerce store owners, online advertising agencies, and website copywriters. Read about our best online business ideas.
Handmade Artisan – Create crafts and art to sell in galleries, craft fairs, and online. Deduct expenses for materials and supplies, travel to fairs, and education. Get ideas for your craft business name.
Services – Offer services for tutoring, organizing, event planning, carpentry, and hairstyling. Deduct all your equipment and material costs, plus your cell phone, tools, and trucks.

Can starting a small business help with taxes?

Yes, the IRS allows you to deduct up to $10,000 ($5,000 in startup costs and $5,000 in organization costs such as incorporation) from your personal taxes a year prior to opening your company, providing a significant tax deduction. Then in the same tax year that you open your doors, you can also deduct additional ongoing expenses like home office expenses (mortgage and utilities), transportation, travel, supplies, advertising costs, and equipment.

It’s important that your business is actually attempting to produce a profit; otherwise, it will be considered a hobby, which doesn’t qualify for deductions. Worse, your “hobby” could be looked at as an attempt to pull one over on the feds. This is crucial because hobby expenses are not tax deductible, and starting a business only for the tax benefits will come with penalties if investigated.

If the IRS comes knocking, they’ll look for evidence that you’re making an honest effort, regardless of your success or skill, to produce a profit. Though there’s no fast and hard list of things they will want to see: a website, accounting records, business-related receipts, a separate bank account, and activities like sales calls or marketing activities will all help to show that you’re endeavoring to create a profitable business.

One other way the IRS looks to see if your business is a bona fide business is the rule of three out of five. This is a way the IRS uses to determine profit motive (even if you don’t make a profit right away). The rule is that if your business made a profit for any three of the past five consecutive years, your company is not just a hobby.

Considering starting your business in Delaware to save taxes? Read about the benefits and risks of starting a business in Delaware.

Tax Information and Resources