Overpaying on income taxes is a real and prevalent issue that affects approximately 2 million American taxpayers each year. This may be in part due to poor tax planning, but it is also because many small and even medium-sized businesses lack sufficient knowledge about tax deductions. This is while large corporations that earn the most, make the most of their available write-offs and use the tax laws to their advantage. If you have a startup or a small business, it’s important that you take note of these biggest business tax deductions.

What Is a Tax Deduction?

Tax deductions are simply expenses that can be deducted from your taxable revenue, which lowers your tax liability as a result. These include all expenses that the IRS deems ordinary and necessary for running a business. Since these terms are ambiguous, it’s helpful to break them down to understand what each category entails.

An ordinary expense is anything that is typical and usual for a business in a specific industry. They also include general expenses that apply to all businesses irrespective of the field they operate in, such as advertising expenses.

A necessary expense, however, has a broader definition. Contrary to what the name might suggest, these expenses don’t need to be indispensable or absolutely necessary but helpful and appropriate. For example, renting an office is not absolutely necessary for a freelance web developer to conduct his business, but it is unequivocally helpful and appropriate.

Of course, there are rules and exclusions for tax deductions. For example, capital expenses—which are paid to buy or upgrade physical assets—are amortized or depreciated over time rather than written off in the year of the purchase.

Startup and Organizational Costs

The first tax deductions new businesses should consider are deductions pertaining to the costs of going into business. These costs include both organizational costs and startup costs.

Organizational costs are the costs of establishing a business entity such as a corporation or partnership. It includes registration fees, costs of accounting services, organizational meetings, training employees, and so forth. Startup costs are all ordinary and necessary costs associated with starting a new business such as research costs, marketing expenses, etc. A business can take a deduction of up to $5,000 for each of these categories. Also, these costs can be deducted even if a business fails, provided that the costs were incurred after making the decision to start the business.

Rent

The cost of renting an office space, building, warehouse, or any other type of property that is used for business purposes is fully deductible on the condition that the business owner does not have or eventually receive equity in the property in question.

Those with a home office may be able to deduct the business portion of their home expenses from their income taxes. Therefore, things such as utilities, internet, insurance, and repairs are deductible so long as you can calculate the portions for your personal and business use.

Supplies, Materials, and Operating Expenses

All expenses associated with the office, tools, and technology that are paid to operate a business can be deducted. These expenses may include everything from pen and paper to computers, software, and subscriptions that are ordinary and necessary for running a business. In a similar fashion to the home office example, if a personal cell phone is used for business purposes, a portion of the cost of the device and its cell phone service can be written off.

COGS

The businesses that sell products can write off their cost of goods sold (COGS). Naturally, these costs include raw materials, direct labor, storage, and overhead costs, but also some indirect costs that are not considered as COGS such as sales force costs.

Labor Costs

Payroll expenses and contractor expenses are fully deductible for all businesses including service-based businesses. These are all costs that a business incurs to pay anyone to provide a service related to that business. It is crucial to have W-4 forms for employees and W-9 forms from hired contractors so that their costs can be deducted from your business income.

Research and Development Tax Credit

To incentivize innovation and stimulate the economy, the US federal government provides businesses with R&D tax credit benefits for the expenses they incur for developing, designing, or improving products, formulas, processes, or software. The R&D credit is defined broadly and can potentially return to businesses up to $250,000 each year. It is not limited to large research-heavy corporations in the biotech sector. Rather, startups and small businesses from a wide array of industries including manufacturing, engineering, software and technology, construction, retail, and agriculture can claim the credit. It is important to note that while both tax deductions and tax credits reduce the tax bill, credits are usually more valuable, as they reduce the tax liability dollar for dollar.