[Disclaimer: Payability is not a certified tax professional. You should always consult a CPA or accountant about your individual business and taxable income.]
One thing that all eCommerce sellers can count on every year is filing taxes. But, tax season is often dreaded. Understanding complicated tax laws can be confusing and time intensive.
However, 30% of small businesses believe they overpay their taxes and could claim more deductions and credits. It’s hard to keep up with the latest rules and know how to take advantage of them.
But while you may not be passionate about tax savings and laws, knowing best practices for tax deductions could literally save your business thousands of dollars. This is your own money that you need to operate and grow your business.
It’s critical for any online business owner to understand how business tax reductions work and what you can potentially write off every year.
How Taxable Income Works
How do business taxes work? You owe taxes based on your profit, which is total revenue minus total expenses. Expenses include cost of goods sold, depreciation expenses, operating expenses, and interest expenses. (Note that not all these expenses are taxed the same). This is your total taxable income.
Your total taxable income level then determines how much you pay in taxes. And in general, the higher your income equals to higher tax pay outs. So, the idea is to reduce your total taxable income in order to pay less taxes.
But, how do you reduce your taxable income? You use deductible expenses to lower it. These can include business-related expenses, investment losses, and employee payroll. It’s also common to refer to deductible expenses as “write offs.” We’ll list common examples below that you can consider.
For example, let’s say your business made $50,000 last year. But, you also calculated $5,000 in deductible expenses. Your total taxable income would be $45,000 ($50,000 minus $5,000). If you didn’t write off your deductible expenses, you would be taxed at the full $50,000 and pay more in total taxes.
Understanding your deductible expenses can save you thousands in the long run. So you won’t overpay in taxes.
Tip: Deductible expenses are different from non-deductible expenses, which can’t be used to lower your taxable income. Non-deductible expenses include personal expenses that are used outside of business.
10 Tax Deductible Expenses for eCommerce Businesses to Know
When getting started with taxes, it’s best to familiarize yourself with common deductible expenses. These are easy expenses you can track and then write off every year from your total taxable income.
The IRS considers an expense tax deductible if it’s “ordinary and necessary;” meaning, it’s an expense incurred commonly in conducting business, and necessary for your business to operate.
This is by no means an all-encompassing list of tax deductions for small businesses (you can find that here for 2020 tax returns). However, these are the most common ones that all business owners should know routinely.
1. Shipping Costs and Packaging Materials
Most sellers don’t realize they can write off any costs from shipping and packaging their goods to customers. You can include postage, packaging boxes, tape, labels, packing materials, printer ink, and shipping meter subscriptions.
Shipping is a necessary and significant expense for any online business. Do you know how much you actually spend? Understanding your tax savings from shipping expenses can also factor in whether you offer free shipping or not.
Tip: Dropshippers can’t write off shipping costs as they’re not responsible for delivering their goods to customers.
2. Home Office
Do you run your business out of your own home or co-working space? If so, you can write off a significant deduction for it.
This only applies if you work solely out of your home or co-working space and not any other alternative workspace.
You can calculate your home office deduction in two ways:
Use a modified calculation of: $5 x office square footage = deduction (with maximum of 300 square feet. You can fill out this total expense on Schedule C of Form 1040.
Or, calculate the percentage of your home’s square footage that is your working space. Then, apply that percentage to your home expenses like rent or mortgage, interest, property taxes, and utilities (heat, electricity, water, etc). You’d report these expenses on Form 8829.
While the second method is more work, it could give you a larger total deduction.
Either way, be sure to take pictures of your home office and maintain records of you working there as proof for the IRS.
3. Home Inventory Storage
If you store inventory at home, you can also deduct your living space expenses. To be eligible, you must use the storage space on a regular basis for products you sell at wholesale or retail. And, your home must be the only location for your business.
This can be an important write off for startups or retail arbitrage sellers who don’t usually need a warehouse or other facility.
4. General Business Expenses (Office Suppliers, Internet, Website, and More)
Remember that the IRS includes any business-related expense that is “ordinary and necessary.” So, you can track and write off everyday expenses that help run your business like:
- Office supplies — Notepads, pens, printers, staplers, even books
- Photography and video equipment
- Cell phone or other phone bills
- Software tools — Any program like email marketing, SEO, paid ads, social media, design
- Website — Your eCommerce or marketplace platform fees and any domain and web hosting fees
While some of these expenses may seem small, they can quickly add up to significant savings.
Whether you advertise on Facebook, Instagram, or through direct mail inserts, these advertising expenses are tax deductible. You’d write off the price for placing the ad and other fees to produce it like a designer or copywriter.
6. Employees and Independent Contractors
You can also write off employee benefits, compensation, and perks like their salaries, paid-time off, education, and more. All expenses must be reasonable and necessary.
You should also include any independent contractors or freelancers hired by your business. The cost of their service is a tax cut. For each worker, you’d submit a 1099 form to the IRS.
7. Financial and Legal Fees
All businesses can deduct certain financial and legal fees from their total taxable income like:
- Professional Services — Business lawyers, CPA, or bookkeeping service
- Interest rates — Can be from business loan or credit cards
- Financial Fees— Can be from regular bank or business account
- Bad debt — If a customer or client owes you money that you’re unable to collect like loans or credit sales
Tip: If self-employed, you can also deduct your contributions to your retirement plans.
8. Insurance (Business and Health)
If you pay a premium for different types of insurances for your business, you can deduct them. These can include fire insurance, professional liability, credit insurance, data breach insurance, and more.
Other types of insurance you can deduct are your own health insurance (if not under someone else’s employer) and long-term care insurance.
Are you always taking classes or other certifications to improve your knowledge and skills? If so, you can also be rewarded by deducting these expenses. You can include educational classes, certifications, workshops, or other forms of training, as long as they directly improve your day-to-day business operations.
Many business owners have to travel to operate their business. Luckily, you can factor in these travel costs as deductible expenses. Travel expenses can include gas mileage, parking fees or other transportation charges, or the full expense of operating a business-only car.
Similar to your home office space, you can calculate travel expenses in two ways:
For a modified version, track dates and miles traveled for business and use the 2021 IRS standard mileage rate of 56 cents per mile (changes yearly).
Or, calculate your total car and travel expenses (gas, oil changes, repairs, etc) and apply as a percentage. So, if you used your car for business 15% of the time, then you’d deduct 15% of your total car expenses in a given year.
How to Prepare for Tax Season
Being informed about your tax benefits can go a long way for your business. It can help you save money and grow your business faster.
For any business, here’s how to better prepare for any tax season:
- Understand the basics of tax deductions for small businesses
- Keep track of all business-related expenses and maintain records and documentation
- Keep personal and business finances and expenses separate
- Hire a tax professional to help you maximize your savings