The timing of tax deductions for your small business depends partially on whether you can count an expense as capital or current. The tax code governs which expenses a business can deduct from their taxes, as well as what year a business can take those deductions in.
Businesses can take deductions for certain expenses the same year they make them. For other expenses, the business must break up the deduction and take it over several years. The first kind of deduction is known as a "current expense," while the second is called a "capital expense." Read on to learn more.
Current Expenses
Current expenses are the day-to-day expenses that keep a small business running, like rent, paper and printer ink. A small business can simply subtract the total amount of all current expenses from the business' gross income during the tax year that the business incurred the expense in.
Capital Expenses
An asset is anything that a small business expects will generate revenue for the business for several years past the original purchase date. Common examples of capital expenses are buildings, equipment and vehicles.
The IRS views capital expenses as investments in the business, thus the business can't simply deduct the money spent on the asset from its gross income. The money hasn't really left the business, it was just transformed into an asset that the business hopes will generate more money. Deductions for capital expenses typically must occur over several years, except where Section 179 applies. Spreading the deduction over multiple tax years - also known as "capitalization", "amortization" or "depreciation" - helps businesses to accurately assess their profitability from year to year.
If a business expects to use something for more than a year, the business should capitalize it.
Section 179
Section 179 allows a business to deduct expenses that the IRS would normally consider capital expenses as if they were current expenses. Section 179 only applies to certain kinds of property, and has an upper limit.
Finally, a business' Section 179 deduction can't exceed its total income for a year. For example, if a business has an income of $200,000 in a year, but placed $250,000 worth of Section 179 property into service during that year, the business could only take a $200,000 Section 179 deduction. The business could carry over the remaining $50,000 in Section 179-eligible deductions to the next year, though.
Repairs vs. Improvements
When a business makes a simple repair on a capitalized item, it can deduct the cost of the repair as a current expense.
If the business makes an improvement on the capitalized item, however, it must capitalize the cost of the improvement. This most commonly applies to real estate -- adding a room, improving the plumbing, etc. - but it can also apply to other things as well, such as business equipment.
The tax code states that a modification is an improvement when:
Have an Attorney Answer Your Small Business Tax Deduction Questions
Tax laws are complicated, but you don't need to decipher them on your own. Allow a trained legal professional to guide you through the business expense process. Contact a local tax attorney to answer your questions about deductions available for small businesses and review any other business tax issues.
