Business Tax Deduction

Expenses that reduce a company's taxable income

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What is a Business Tax Deduction?

A business or corporate tax deduction refers to an item that is subtracted from revenue in order to determine a company’s taxable income. Tax deductions are considered a form of tax relief for the company.

Tax Deduction

Companies will file their appropriate tax returns at least annually. These returns will show the company’s gross income, as well as its claimed deductions, which will determine the company’s taxable income. The taxable income will then be multiplied by the appropriate tax rate to determine how much money a company owes in corporate taxes.

It is important to note that companies must file their tax return in order to be eligible for deductions as well as avoiding potential penalty payments. Additionally, there may also be certain limits on various deductions. For example, in some cases the U.S. Internal Revenue Service (IRS) does not allow a company to deduct 100% of its interest expense in a given tax year.

Companies will need to provide proof of the deductions in case they are audited by taxing authority.

Key Highlights

  • A tax deduction refers to an item that is subtracted from revenue in order to determine a company’s taxable income. Tax deductions are considered a form of tax relief for the company.
  • Common business tax deductions include: supplies and product costs, depreciation, wages and salaries, and interest expense.
  • Tax credits are another form of tax relief but differ from deductions in that credits directly reduce a company’s taxes on a one-for-one basis.

Common Business Tax Deductions

Companies can claim tax deductions for certain expenses that are incurred to operate and maintain the company’s business. Once again, depending on where the company is located, there may be different tax deductions. Below is a list of business expenses that can typically be deducted to reduce the organization’s taxes:

Supplies and product costs

Businesses can claim deductions for supplies and products used either directly or indirectly in order to provide goods and services for customers. For instance, supplies can be tools and machinery used by a construction worker. Or it can be the salary of a consultant advising on a project.

Depreciation and amortization

Businesses can also reduce their tax liability by deducting the depreciation on equipment and/or owned office space. If the equipment or office space is leased, the company can deduct the lease cost. Additionally, in certain instances companies can deduct the amortization of intangible assets as well.

Wages, salaries, and other benefits

Companies can deduct gross wages, salaries and benefits that a company pays to its employees.

Interest expense

Interest expense is the cost of using debt financing and is typically tax deductible in many jurisdictions around the world.

Banking and administration fees

Companies may deduct administration expenses incurred to run the business. These can include banking fees, marketing expenditures, litigation costs and travel.

Tax Deductions vs. Tax Credits

It is also important to consider the difference between tax deductions and tax credits. Although both tax incentives are similar, they are different in how they are carried out.

A tax deduction is an amount that is subtracted from revenue to determine taxable income. As such, tax deductions can be used to reduce your tax liability.

On the other hand, tax credits are deductions that directly reduce taxes payable. In other words, these credits are applied directly to taxes payable and reduce taxes payable on a one-for-one basis. For example, assume a company owes $1 million in taxes after factoring in all tax deductions. The company also has $200,000 in tax credits. The company uses these tax credits to reduce taxes payable to $800,000 ($1,000,000 minus $200,000).

Because credits reduce taxes on a one-for-one basis, they are even more valuable than a deduction, which only reduce taxes by the amount of the deduction times the applicable tax rate (tax shield).

Tax credits are either refundable or non-refundable. Refundable tax credits are paid back to the taxpayer by a reduction in taxes payable or via a refund. Non-refundable tax credits are only available under certain conditions and can only reduce taxes payable.

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