As a small business owner, every penny counts when you are buying supplies and equipment for your business. Luckily, every penny also counts when you report those purchases as tax deductions. In fact, according to the IRS, everything you purchase that is “ordinary and necessary” to run your business is tax deductible. In IRS terms, an “ordinary” expense is one that is “common and accepted” in your trade, and a “necessary” expense is one that is “helpful and appropriate” to running your business. Therefore, something you purchase does not have to be “indispensable” to your business as long as it is reasonable. For example, a nail salon may be able to function without magazines – but they keep customers amused and are a reasonable, deductible purchase.
Note though, that there is an important distinction between the types of things you purchase for your business and how you report them on your taxes. Essentially, there are two categories: current expenses and capital expenses. Let’s take a look at each of these and how they may apply to your small business.
A current expense is anything that you purchase, to be used within a year, as a day to day expense to keep your business running. Current expenses are fully deductible from your gross income on your tax return. For example, if you run a deli, the cost of napkins, straws, paper wrap, paper bags, receipt paper, boxes, pens, pencils, cleaning supplies, rags and more are considered current expenses. Likewise, if you run a consulting firm, printer paper, post-it notes, printer ink, stationery, postage and shipping costs, folders, staples, paper clips, and legal pads might be typical current expenses. Be sure and save receipts for all of these purchases and deduct them on your tax return.
The IRS views a capital expense as something that is more of an asset or investment in your business that you expect to use for more than one year. Capital expenses are spread out and deducted from your taxes over several years, rather than as one big deduction in the year you purchased the item. Using the example above, if you run a deli and purchase a car to use for food deliveries – that is a capital expense as it will benefit your business for more than one year and it is an investment in building your business. In the example of a consulting firm, a capital expense would be a new computer system or new office furniture. When taking capital expenses, you deduct the cost of the item over a number of years. So, if you purchase a car for $20,000 – you would might deduct $4,000 on your taxes for 5 years, rather than deducting the entire $20,000 the year you purchased the car.
While determining current expenses is fairly straightforward, capital expenses are more complicated and involve rules of depreciation and investment. Be sure and consult a tax professional if you have any questions about what kind of expenses you have or how to deduct them.