Starting a small business 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.
Check out our big list of business startup costs that are tax-deductible here.
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 allowed tax write-offs, and cautions on how to prove that your business is not merely a hobby (for which deductions are not allowed).
Expenses Tax Deductions for Starting a Business
There are two types of expenses that you can deduct from your taxes — startup costs and ongoing operating expenses.
Startup Cost Tax Write-Offs
The IRS allows three types of startup costs eligible for tax deductions. You can only write them off of your taxes if you actually opened 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 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 correctly estimate your startup budget and capital needs — including costs listed by industry in our guide here.
Business Operational Tax Deductions 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 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 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
- Office Supplies
- Insurance Premiums
- Education – Any education that will help in your business can be expensed, from training on how to use Photoshop to classes on bookkeeping.
Best Businesses to Start Today
- Consulting – This can be home-based, where you travel to your customers or consult via telephone and Internet. Deduct costs for home office space, telephone lines, internet access fees, and computer equipment.
- Internet – This can be 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 on our list.
- 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. Then in the same tax year that you open your doors, you can also deduct additional ongoing expenses such as home offices (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, or worse 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 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 in our article.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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