Samir Harith is the owner of The Comic Accountant, committed to helping small business owners understand accounting and finance through comics.
OPINION: Hello accounting fans.
One of the benefits of owning a business is the ability to claim tax-deductible business expenses. This means that you can reduce your profits (and your taxes) just by spending money on your business. However, you must remember that not all expenses are tax deductible. Deducting the wrong expenses can get you in trouble with the tax department.
To avoid this, here are two simple tests you can use to determine whether an expense is tax deductible or not.
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Does this expense help my business generate revenue?
The first step is to ask if the expense helps generate revenue for your business. For instance:
You buy clothes from a wholesaler for $30 and then sell them at retail for $50. The $30 you spent is an expense that you used to generate revenue directly. This expenditure passes the first test.
Another example: you pay rent of $300 per week for your office. Your office is your workplace. This is where you meet clients, do your work, and plan how to grow your business. Indirectly, that $300 per week that you spend contributes to your business’s ability to generate revenue. This also passes the first test.
A non-deductible example would be: You spent $1,000 on your favorite band’s last concert ticket. It has absolutely nothing to do with your business. It cannot, however imaginatively, be a business expense. It is not a business expense.
Do you get any kind of personal benefit from it?
This is where things get a little complicated. Typically, 90% of business expenses can be allocated using the first test. But some expenses can have both a personal and professional part. For instance:
You work from home. It costs $800 a year for the phone and Internet bill at home. Working without an internet connection from home is impossible, so this expense contributes to your professional income. However, since it is the home phone and internet bill, you are still using it for personal purposes. Your kids watch Youtube on it, your partner uses it to do accounting at home, and you use it to watch cat memes (which I do in my spare time).
Another example is the fuel spent on your personal car. Unless you are a trader or work in a trade where physical travel is essential, motor vehicle expenses may not be 100% reimbursable. You can only use 50% of your car for business purposes and the remaining 50% for personal shopping. Your fuel expenses always bring you a personal benefit.
In these first two cases, what you need to do is claim the part that relates to your business. For telephone and Internet, the general requirement is to claim 50% of any home telephone and Internet expenditure as a business expense. With personal cars, you’ll need to keep a log to calculate your business usage percentage, then use that percentage to claim some of your fuel, repairs, insurance, and other running costs for your car.
Is it a significant personal benefit?
Some expenses will help us run the business. But they may seem like too much personal benefit to make that connection.
An example of this would be: You paid $400 for a spa day. Business is tough and life is stressful. You need a break. Yes, a break will help you improve and earn more money for your business, right? Perhaps, but it is difficult to establish a causal link between this expense and the generation of income for the company. This expense cannot be claimed.
Another example would be: You are a single parent working hard to run a business and have three young children. You pay $80 a week for a babysitter to watch your kids while you do your job. Having the kids on your back means you can work better. Better work equals more money! While this can help you generate revenue for the business, it provides you with a significant personal benefit. There’s nothing stopping you from using your free time to partake in that $400 spa day you bought earlier (instead of actually working on the business). This expense cannot be claimed either.
A final example is: You are going to a work conference. You need new stylish shoes. After all, you don’t want shabby shoes at the biggest business conference of the year in your industry. Good looks equal good business opportunities, right? Unfortunately, since said novelty shoes can still be worn outside of a work setting (and realistically, they’ll be used primarily for personal purposes), you can’t claim this as an expense.
What about entertainment expenses?
Take customers out for drinks, buy meals for your team members, and buy gifts for customers. These are examples of transactions that fall into the broad category of “entertainment” expenses. The general rule for entertainment expenses is that they are only 50% deductible.
In most cases, buying food for your customer will not directly generate more revenue for you. But it helps build that relationship, and they’re more likely to spend on your business in the future. Note that the purchase of meals for you alone is not deductible as entertainment expenses (see: personal benefit above). So remember, never eat alone if you are a business owner. Always invite a client or team member so you can claim them as entertainment expenses.
This is just a simple guide
There you have it, a few simple ways to make sure you’re claiming the correct expenses for your business. Some expenses may also depend on the type of business you work for. If you own rental properties, interest charges on mortgage repayments are being phased out on some properties and you will not be able to claim the full amount of tax deductions. On the other hand, if you’re not running a rental property business, interest charges are still 100% refundable.
As your business grows, you will come across more complicated transactions that will leave you perplexed. This guide may not be able to answer all your tax questions. In this case, you may want to consult with a tax agent to help you better claim the right amount of expenses for your business.
Good deduction !