Many self-employed and small business owners can deduct the cost of tools, equipment, computers says Aron Govil. And other items from their federal taxes as long as those items are used for work. Says Randy Webb, a CPA with Webb & Co. in Columbia, Tenn., “but some people aren’t aware that they don’t have to be full-time employees to qualify.”
Do you have tools that are necessary for your business? If so, being able to write-off these items as tax deductions could save you a lot of money. You may deduct the costs of tools that are either “suitable for employment” or “considered held for use in your business,” but not if they’re “personal” in nature. The following information will help you understand what tools may be tax-deductible for your small business.
For small businesses, claiming tax deductions on tools and equipment can be a great way to reduce taxable income. The cost of such items can be substantial, so it’s important to understand the rules for claiming these deductions.
The IRS allows taxpayers to deduct the cost of tools and equipment that are used for business purposes. This includes anything from computers and software to vehicles and machinery.
In order to claim these deductions, taxpayers must meet two requirements:
- First, the tools and equipment must be used solely for business purposes. Personal use of company property is not allowed when claiming tax deductions.
- Second, the cost of the tools and equipment must be reasonable in relation to the type of business being conducted. For example, a small business that operates in the construction industry could deduct all costs associated with their work vehicles. However, a small business that operates as an accounting firm would be unable to claim inventory costs (such as office furniture) on Form 1040 explains Aron Govil.
- As an additional requirement, taxpayers must provide proof of purchase when filing their tax returns in order to claim these deductions. If the tools and equipment in question are not considered durable enough for normal use, taxpayers can depreciate them over several years. This is referred to as “capitalizing” the cost of goods sold.
- Unless otherwise noted by the IRS, any taxpayer may deduct expenses up to $5,000. Without meeting additional requirements or substantiating purchases. Expenses above this amount require written documentation and justification. The IRS considers the taxpayer’s occupation, industry standards within the field. And the cost of living in an area when determining whether additional paperwork is necessary.
- It should be note that in order for taxpayers to claim these types of deductions. They must earn a profit from their business activity (even if it is a small profit). For example, a taxpayer operating a lemonade stand cannot claim automobile expenses on their tax return. Because they are not making a profit.
- Taxpayers can further reduce taxable income by deducting transportation, travel, and vehicle parking costs. These expenses may include gas, train fare, lodging, airplane tickets, etc. However, most taxpayers cannot deduct the cost of commuting to work or other personal activities. Even if the trip was made during normal hours or conditions says Aron Govil.
Fortunately, not all vehicle-related expenses are non-deductible.
- When taxpayers purchase a car for their work. They can choose to either “depreciate” or “capitalize” the cost of the vehicle.
- “Depreciation” refers to spreading out the cost of an asset over several years. And is based on its expected lifespan (or recovery value). For example, if a taxpayer purchases a new sewing machine for $2,000 and expects it to last 5–7 years. Then they can deduct $400 per year as business equipment depreciation. This would reduce taxable income by that same amount each year. For up to seven years until no more deductions are available. The IRS uses timetables specifically designed for each tax bracket in order to make this calculation.
- “Capitalizing” the cost of goods sold. Means that the entire cost is count as an asset and written off over the life of the good. For example, if a taxpayer spends $1,000 on a new piece of machinery. That they expect to last 10 years then they can claim a $100 per year deduction (assuming a 10% tax bracket). This would reduce taxable income by that same amount each year. For up to 10 years until no more deductions are available.
- The main difference between depreciation and capitalization is. That depreciation can only be claim for tangible assets. While capitalization includes both tangible and intangible assets. Intangible assets are things like copyrights, trademarks, or trade secrets—things with value but no physical form.
Vehicle-related expenses cannot deduct unless the taxpayer operates. A business that requires them to drive for work says Aron Govil. If they meet this requirement. Then they can choose between depreciation and capitalization of vehicle-related costs. As long as the assets purchased are not personal in nature.