When it comes to taxes, of prime concern for business owners is “what can I deduct?” The answer isn’t always so straight forward. The IRS defines a deductible business expense as one that is Ordinary and Necessary in the course of business operations. It doesn’t get any more elaborate within the Internal Revenue Code.
So before asking yourself what is deductible, approach this question as “what do I need to spend my money on to generate another dollar of revenue?”
These expenses can be your usual:
The proprietors can easily identify the aforementioned as valid deductions.
A follow up question that is often asked is, “what is depreciation?” The concept of depreciation is often confused with images of large buildings, expensive infrastructure equipment, and so forth. At the broadest level, depreciation occurs when a business purchases an asset that will help it generate revenue - is eroded over time.
Let’s take a look at an example:
During the pandemic, Eric started a business from home doing digital advertising for local businesses. Eric purchased some general office supplies (ie. paper, folders, etc.) alongside a new computer for $3,000. Eric believes this computer will help him with handling digital art, video editing, and other advertising activities for his clients.
Eric has essentially purchased an asset that will help his business generate more revenue over time. Eric will depreciate the cost of his computer over a period of 5 years. Depreciation will help Eric reduce future income by this expense.
There are many different types of assets that can be depreciated. They include computers, vehicles, high end furniture, rental buildings, and the list goes on. These assets can also be sold in the future - generating a further gain (or loss) - unlike general supplies that get used up (are un-resellable).