Tax Benefits of Opening a Business

Believe it or not, entrepreneurs, freelancers, and business owners of all types may have a reason to look forward to filing their taxes: getting tax perks. When you launch and operate a small business, you can deduct many expenses from your tax bill. 

Learn what tax benefits you might receive next tax season when you start and run a business, what you can write off, and how much you can deduct on your tax return. 

What Are the Tax Benefits to Starting a Business?

Opening a business has tax benefits small businesses can take advantage of. The Internal Revenue Service (IRS) allows independent contractors and small business owners to write off many startup costs and ongoing expenses involved in running your business. Whether you’re a sole proprietor or an LLC member, you can deduct most of the same purchases. 

Let’s explore how you can lower your tax liability by forming a sole proprietorship or an LLC.

How Will Owning a Small Business Affect My Taxes?

Small business taxes work differently than personal taxes, and how your business taxes work depends on the type of business structure you have. Sole proprietorships and LLCs — even if there are multiple members involved in the LLC or it’s a partnership — automatically operate using pass-through taxation. This means that the taxes get transferred to the owner’s (or owners’) personal income tax return (or returns) unless you specify otherwise. So you don’t usually have to pay tax on your business income. 

However, the tax benefits of LLCs can work differently. You can choose to be taxed as a corporation instead of a pass-through entity. This choice can have some perks but also requires you to pay a corporate income tax, depending on which state you live in.

Small business owners and self-employed individuals can also deduct a lot more on their tax returns than people who don’t own businesses. The Internal Revenue Service (IRS) has rules for what costs small business owners can deduct from their taxable income. Deductions will lower the amount of your taxable income and often reduce the amount you pay in federal tax.

Keep in mind that a deduction and a tax credit are not the same thing. A tax credit reduces dollar-for-dollar how much you owe in taxes. A deduction, on the other hand, lowers how much of your total business income can be taxed.

What Are Three Tax Benefits of Owning a Small Business?

Three of the most exciting tax write-offs of being a business owner are:

1. Home office deduction

Working from home has many benefits, including writing it off on your taxes. There are two methods that the IRS uses for figuring out how much of your home office can be deducted. But you can only write off the percentage of your home that you use exclusively for business purposes. Similarly, you can usually deduct the part of your real estate taxes that is used toward a business property.

2. Interest payments

Borrowing funding to help your business succeed can be a great move, but interest payments can be rough. The good news is that you can write off the interest you pay on small business loans, which makes paying interest a little easier. However, you won’t be able to deduct the interest you pay on business credit cards.

3. Professional fees

As a business owner, you often need to bring in additional help to get your business up and running or to keep it operating. You can often write off these fees. These expenses may include business formation services, accounting services or bookkeeping expenses, or lawyer fees.

What Can I Write Off When Starting a Business?

Here are some of the other most common write-offs that many small business owners don’t think about when filling out their tax forms:

• Insurance premiums, like health insurance for yourself or employees, or business insurance
• Contributions to your retirement plan
• A portion of your self-employment taxes
• Business subscriptions like web hosting, marketing, or publications
• Car expenses for business use (deduct mileage using the standard mileage rate)
• Travel expenses for business trips
• Property taxes for things like cars, equipment, or machinery
• Education expenses to expand your business know-how
• Office supplies and furniture like a desk, chairs, or a computer
• Wireless internet and telephone bills
• Employee salaries and benefits
• Business meals and entertainment for clients
• Marketing costs

The IRS breaks down what businesses can deduct on their taxes. However, working with a professional can help you maximize your deductions because they know the ins-and-outs of what you can deduct. To dive deeper read more on business taxes here. 

Can Business Expenses Offset Earned Income?

When you’re just starting out or have a difficult year, your business may not make a profit. Your small business tax deductions may be larger than your taxable income. This is perfectly normal and legal, but the one thing you want to watch out for is taking a loss too many years in a row. If you’re an LLC, you want to avoid making no profit for more than two or three years out of every five because otherwise, you’re in danger of the IRS classifying your business as a hobby. You can’t deduct expenses for hobbies.

How Much in Startup Costs Can I Deduct?

When tax time comes around, you might be wondering how much you can deduct for costs to create your new business. If you choose to deduct these costs, the IRS sets a deduction limit of up to $5,000 for startup expenses and $5,000 for organizational costs. Startup costs are anything you bought to launch your business (like subscriptions, website expenses, or office furniture) while organizational expenses are what you paid to form your business entity (like business formation services, filing fees, or lawyer fees).

You can take this deduction only if you spend $50,000 or less launching your business — otherwise, you’ll need to amortize these costs.

As you begin the process of launching your business, don’t forget to take the key step of working toward building business credit. Check out Nav’s comprehensive guide on how to establish business credit to get started.

Frequently asked questions

How much can you write off the first year in business?

When you launch a new business, you can write off up to $10,000 total — $5,000 in startup costs and $5,000 in organizational expenses. This applies as long as you didn’t spend over $50,000 to start your business, which causes different IRS rules to apply.

Do I pay taxes if I lose money in business?

You’ll still file a tax return even if your business doesn’t make a profit. The amount you pay (if anything) will depend on your gross profit and the amount of your deductions.

Is it worth being a small business owner?

As a taxpayer, it might be worth becoming a small business owner because of the tax benefits of opening a business. If you have the bandwidth to run a business, you can lower your taxable income by running a business. It’s always a good idea to talk to a tax professional before deciding whether or not it makes sense in your case.