Your Burning Business Tax Questions, Answered by a CPA

Can you count a local sports team sponsorship as a business expense? If you discuss your advertising strategy over coffee with your partner, is it considered a business lunch? And just what does a certified public accountant do when you hand them a pile of gas receipts?

If you’re a small business owner getting ready to file your taxes this year, you likely have questions about how to make the most of your taxes – and how to stay in compliance with the IRS. Bankrate’s Kem Washington, CPA and former revenue agent and criminal investigator for the IRS, is here to answer them.

How do I maximize my business tax deductions?

That’s a big question. Maximizing your tax deductions involves careful record-keeping and consideration of how exactly you spend your company’s money. Let’s break it down a bit.

How can businesses prepare to maximize their deductions?

The first thing a business owner needs to do at the top of the year is get an idea of their financials and their profit and loss statements in order. Then, they need to review those statements so that they can identify opportunities for deductions.

This might be unwelcome news at the beginning of tax season, but ultimately you have to be proactive throughout the entire year. You can’t wait until tax time to start looking at your deductions to determine whether or not you’re able to maximize them.

It’s good practice to meet with a CPA or other tax professional quarterly. That way you can review your profit and loss statement and determine if there arer any strategies you should implement throughout the year to maximize your tax deductions.

What are the ways you can deduct expenses as a business?

Having complete records of your day-to-day business expenses is one of the most helpful ways to maximize deductions. This includes general expenses like your day-to-day operation expenses – that could be your payroll, rent, office supplies and such.

Then you also have your larger investments such as equipment purchases and large assets for your business, and in some cases you can deduct that as an expense on your tax. Depending on the equipment and its depreciation, you may be able to write the entire cost off on your taxes.

So what counts as a business expense?

The rule the IRS uses is “ordinary and necessary for the business.” So if the expense is normal for the industry, and essential to its function, then it’s a deductible expense.

So if your trade requires you to incur education expenses, or to contract laborers, that’s considered necessary and qualifies as an expense.

Keep in mind that whatever expense that you deduct on a tax return, it has to be reasonable, as considered by the IRS, and it has to be necessary to carry on the business.

Anything that’s out of line for your business is not considered ordinary or necessary by the IRS. You can’t deduct buying an arcade if you’re a law firm, for example.

Can I deduct my personal internet, car, home office or phone bill as a business expense if I use it for business?

The answer is yes and no.

With the phone line, there’s a rule with the IRS that expressly states that your first home phone line could never be deducted, even if you’re using it for business.

You can claim a portion of your internet if it’s used for business.

If you have a home office at your home, you can take it in one of two ways. First, you can take a percentage of certain expenses for your home.For example, if your home office is about 100 square feet, and your home is a thousand square feet, you can deduct 10 percent of internet, insurance and other expenses dedicated to that space.

The other way is what’s called a simplified version. With a simplified version, you can deduct $5 per square foot (maximum 300 square feet). So if you have a hundred square foot office, you can take a $500 deduction on your tax return.

The same can be applied for using your personal car for business purposes. If you’re a sole proprietor, and you’re using your car for business errands as well, you just have to determine what percentage of expenses such as gas, maintenance and insurance you’re spending on business.

Let’s say you spend $2,000 worth on gas and $1,000 for repairs. You can apply that percentage to your total expenses, and take that percentage and apply it to your deduction. You can also deduct based on your mileage, and calculate the deduction by the standard mileage rate. This is why it’s important to keep track of your expenses and mileage when you’re using it for business.

Is there a maximum deduction for business expenses?

The short answer is that no, there is no maximum.

However, you do have to be mindful of what and how much you’re deducting. For example, if your annual revenue is $50,000, but every year you’re claiming expenses of $80,000, it’ll raise red flags from the IRS. The IRS may consider your activity as a hobby and limit your deductions.

Are loan interest payments deductible? Does it have to be a business loan?

Interest payments are deductible – but only for the interest, not the entire loan payment.

It doesn’t have to be a business loan, either. If you get a personal loan or use your credit card to pay for a business expense, you can deduct the percentage of the interest on the loan that you used for the business expense.

If you don’t have a good understanding of business taxes, then you definitely want to consider hiring a CPA.

Should I hire a CPA for my business?

While there isn’t necessarily an income or transaction threshold for hiring a CPA, what you want to look at is your own tax knowledge. If you don’t have a good understanding of business taxes, then you definitely want to consider hiring a CPA.

Even if it’s your first year in business, and you’ve never prepared a business tax return, you’ll still want to consider getting a CPA involved.

Another factor, I think, is that unless your business is very straightforward – maybe you made under $20,000 this year and you only have a few deductions – then using a CPA can be advantageous. CPAs can help you build certain strategies you need to make throughout the year. If you’re a small business owner, you may want to consider a CPA.

What should I look for in a CPA?

First of all, you’ll want to see if your CPA can handle your industry right. For example, if you’re someone who’s a consultant and you have a small consulting practice, you want to ask your CPA if they’ve dealt with consulting practices before. Make certain that they have expertise in your field, because they’ll know what’s normal for expenses and deductions.

The second thing you want to do is make certain that the CPA is someone that you can connect with year round. They can help you manage your finances and prepare for filing early. That can help your deductions. Thirdly, get referrals by word-of-mouth. Talk to other business owners and ask, ‘Who are you using? How was your experience? What can I expect?’

Last, but certainly not least, find out how your CPA charges. Some CPAs charge by the hour, some CPAs charge by the forms.

Is tax software a good substitute for business taxes?

If you have a complex tax return, you may need a CPA. But if you have a simple tax return, using an online tax software program is very advantageous. They’re typically lower than paying for CPA services. However, if your tax return is ‘s complex, I think you still need to go into the direction with the CPA.

I’ve reviewed a lot of tax software, and I think a lot of them are good. But I think, again, if you have a complex tax return, I don’t think tax software would be your best place to go, because even if you hire additional help, it’s only so limited.

I believe it will take years or even decades before AI will be able to replace CPAs because of the complexity of the tax code.

Is AI or ChatGPT a good substitute for a CPA?

Some people think AI will replace human accountants. I don’t think it will happen anytime soon unless the tax code gets a lot simpler, and that hasn’t happened.

Right now there’s not a lot of good tools when it comes to AI and tax law. I’ve tested AI apps and determined that some information provided isn’t correct when it comes to taxes. I believe it will take years or even decades before AI will be able to replace CPAs because of the complexity of the tax code.

Should I classify my business as a sole proprietorship, an S Corporation or an LLC for the biggest tax advantage?

This is a loaded question, but I’m going to try to make it as simple as possible.

Number one: An LLC could file as an S Corporation, and an LLC can also be an sole proprietor that files a Schedule C.

An LLC is registered with the state, typically where you reside. However, you can choose how you want your LLC taxed by the IRS. Let me give you an example. an LLC may decide, instead of being taxed as a sole proprietor, to request from the IRS to tax the LLC as an S corporation. An LLC with two or more partners can be taxed as a partnership with the IRS

It’s a good idea to sit down with a CPA to determine how you should file and which option would yield the lower amount of taxes.

If I get money to launch my business from a crowdfunding campaign, is it taxed as income?

This, too, is not a straightforward answer. The IRS considers the facts and circumstances when determining whether money received from crowdfunding is taxable. If you do receive funds from a crowdfunding source, consider meeting with a CPA to determine whether the amount is taxable or not.

What if I get startup funds from a friend or family member?

If you receive a gift from a friend or family member, it is not considered taxable income. If you did work for that family member or friend for that money, then it’s going to be considered income, but if it is purely a gift, it is not considered taxable. If you do receive gifts of any kind, make certain that you have good accounting records that you can show that this was actually the case.

Can I get a refund on my taxes from a business loss?

You could in certain circumstances. Let’s say, for instance, you file your Schedule C with your personal tax return, and you have a $20,000 loss.

Then let’s say your business isn’t your only source of income. If you have W2 income, and you have some withholdings, $20,000 loss will reduce your taxable wages. If you had withholdings, that could generate a refund.

You can, in some cases, carry losses from a previous year to the current year. However, you want to be careful, because when you are taking too many losses year after year, the IRS may step in and classify your business as a hobby.

What are some common myths or bad advice about business taxes?

People get their deductions wrong. I’ve heard social media influencers advise people to deduct their wardrobe as a business expense.

Now, the IRS won’t allow you to take a deduction for your personal clothes, so that is concerning to me when I hear this type of advice. Typically, in order to make a deduction for clothes, it has to be a uniform like for a nurse or a doctor, and something that you can’t wear every day.