2021 Business Tax Preparation
Tax season is almost here and COVID-19 has changed some of the rules for SMBs.
Here's what you need to know:
- COVID-19 has changed some of the rules governing SMB deductions
- There are 2 different ways to calculate home office expenses
- Be sure to consult with a tax professional about any deductions you calculate
It’s time for small to medium-sized business owners to begin compiling information to file their taxes for 2021. This year has been challenging, so for many small and midsize businesses, maximizing tax deductions and credits is critical. Whether it’s for the most basic or the most complex deductions, use this checklist to assure you’re taking advantage of all the opportunities available under the law.
The IRS has information SMBs can use to help compile the necessary paperwork for filing. If you received funds under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, Paycheck Protection Program (PPP), the PPP Flexibility Act, and/or Economic Injury Disaster Loans (EIDL) there may be specific exclusions and inclusions to consider for the coming year’s taxes. For the best results, it’s often recommended you see the help of a tax professional. However, here are some things you can compile for them to get the most generous refund or the least impactful tax bill.
Advertising and promotion
The costs associated with advertising and promotion are 100% deductible. In 2020, many businesses launched new websites or upgraded existing websites to include online ordering and payments. Other advertising and promotional expenses include paying for business logos, along with online or print ad space. Social media campaign costs are also deductible, as well as sponsoring an event. Any costs associated with promoting your business, virtually or in person, is deductible.
DoorDash, GrubHub or Instacart costs are legitimate business expenses you can use to offset your business earnings for the year.
If your SMB began using food or other delivery services, the cost of these are also deductions. DoorDash, GrubHub or Instacart costs are legitimate business expenses you can use to offset your business earnings for the year.
Use your own delivery person? Any mileage costs incurred, along with salaries, are deductible. For 2020 the standard mileage deduction is 57.5 cents per mile.
Your business may qualify for a 50% deduction on food or meals you provide to clients; the expense must be necessary and not lavishly expensive. Make sure you (or an employee) were present at the meal. If you provide meals to employees who are working late, for example, the deduction is also 50%. However, office parties and picnics are deductible at 100% of the cost.
Business owners know all the expenses incurred to keep the company running are deductible: materials, supplies, rent/mortgage interest, utilities, salaries, health insurance, rental of equipment, etc. But many SMBs neglect some of the smaller costs that add up when preparing their taxes.
If you have a television in your waiting room or provide Wi-Fi access to customers, deduct those costs. If you place flowers on every table in your restaurant or hire a local artist to decorate your windows for the season, make sure to use those receipts as well. Petty cash costs are often neglected by SMBs. Having cash on hand to run out for supplies is necessary; keeping those receipts is critical.
If you have a television in your waiting room or provide Wi-Fi access to customers, deduct those costs. If you place flowers on every table in your restaurant or hire a local artist to decorate your windows for the season, make sure to use those receipts as well.
The coverage that protects your business is deductible, as is liability insurance and group health, dental, vision, life and workers’ compensation insurance for employees. Did you add insurance this year for delivery services? Add that to your list of deductions. Many SMBs acquired business interruption insurance this year in response to the pandemic — that is also deductible.
Bank fees, credit card/merchant fees, monthly costs for software or cloud services, or internet access fees are all legitimate expenses that can offset your tax burden. Legal and accounting fees that are necessary to the operation of the business are another typical SMB expense. Keep track of billing for these as well as fees paid to third-parties like payroll processors, PEOs, background check companies, and other professional services to compile your taxes for the coming year.
Taxes and licenses
Many types of taxes are deductible from your federal tax burden. These include state income and payroll taxes, property and real estate taxes, some sales and excise taxes and others. Make sure to check with your tax professional to assure all taxes (even local) are deducted correctly on your federal return.
Business licenses, including licenses you pay for your employees, are also a legitimate business expense. In addition to keeping them current, keep the receipts for their cost.
The interest you pay on loans, credit cards, or lines of credit that are used to operate your business are also deductible, provided they meet certain criteria. Your business must be legally liable for the debt: both you and the lender intend the amount be repaid. This can be difficult to support if the loan is from a family member, for example. If you accept a loan from a relative or friend, make sure there is a structure to repayment and the loan has interest payments that are quantifiable.
Home office expense
Whether your business has always required spending time managing operations from home, or the COVID-19 pandemic forced you to work remotely, home office expenses are a legitimate business deduction.
Whether your business has always required spending time managing operations from home, or the COVID-19 pandemic forced you to work remotely, home office expenses are a legitimate business deduction. The IRS has 2 ways to calculate what you can deduct for your home office. The “simplified method” allows you to deduct $5 per square foot of your home, up to a maximum of 300 square feet or $1,500, for home office expenses.
The “standard method” tracks all the expenses of maintaining your home, including rent/mortgage, taxes, utilities, association fees, taxes, etc. To calculate with the standard method, multiply these expenses by the percentage of your home devoted to business use. Then calculate the amount of the deduction. For example, the overall cost to turn the key in your home is $2,000: mortgage, taxes, utilities, etc. If your business utilizes 25% of the space in your home: $500 would be the deduction. Calculating home office expenses can be complex, so make sure to consult a tax professional when leveraging the final deductions.
Costs for video conferencing services or calls are a new expense you may have incurred in 2020; be sure to itemize these on your taxes. In addition to business communication costs, you may be able to deduct some of your personal communication costs, as well.
If you use your cell phone/landline or home internet connection to conduct a portion of your business, that may be a legitimate expense. Calculate how much time you spend on business versus personal calls, and offset the personal bill. Say your cell phone bill is $50 per month, but half of your calls are for business. Your deduction would be $25 per month.
Retirement plan costs
The cost of administering a retirement plan for employees, as well as contributions you make to their funds are also deductible. For businesses looking to start a retirement plan for staffers, there are some incentives available to help get the plan up and running.
Generally the inventory you hold is not considered an immediate deduction. Instead, businesses leverage inventory items through the “cost of goods sold” method of accounting. This method reduces sales income. Many small service-based businesses, like hair salons, use the cost of goods sold method for products they sell in addition to their services.
Alternately, some small businesses use the “cash method of accounting,” which allows them to treat inventory items as materials and supplies, both of which are currently deductible.
To qualify for the cash method, a small business must have annual average gross receipts not exceeding $10 million for 3 prior years. Or, it must not exceed $10 million for the total of years if the business is less than 3 years old. Switching accounting methods from costs of goods sold to materials and supplies isn’t automatic. You must file for a change in accounting method on IRS Form 3115. Details are available at the IRS site.
If you loaned money to a staff member or a vendor defaulted on payment, these bad debts are a deductible loss on your taxes. You’ll need documentation to verify the money was provided if you did extend a loan. If a vendor or customer with an outstanding balance defaults, documentation verifying that the debtor has gone out of business, for example, might be sufficient.
If you sponsored a Little League team or made charitable donations to local or national charities, those expenses are deductible. Additionally, many small restaurants provided meals this year for local hospital staffers and first responders. Make sure to itemize those receipts as contributions on your upcoming taxes.
Net operating losses
The coronavirus pandemic has put many SMBs in the red for 2020. Companies that sustained a net operating loss (NOL) in 2020 (or earlier if already itemized) can claim that loss to reduce their tax obligation for previous or future tax years.
For 2020, the CARES Act removed the limit of NOL for some small businesses (not corporations) and currently there is no limit on how much business loss you can take for the year. Detailed information is provided by the IRS on NOL and how to prepare your taxes. For these complicated deductions especially, we recommend working with a tax professional.
You can expense whatever you purchase for your business immediately. Or, the cost may be spread out over years as depreciated assets to lower your future tax burden.
Small businesses generally expense assets less than $2,500 per item in the year purchased, but there are specific rules for depreciation and bonus depreciation that may make spacing the cost out more advantageous. Consult your tax professional to find the right option for your business.
Whether 2020 presented your business with challenges or not, it’s important to make sure your taxes reflect all the deductions you’re entitled to. Working with a tax professional or on your own, filing on time and correctly is necessary to keep your SMB compliant and growing.