How to Write Off Business Expenses for an LLC

Defining Deductible Business Expenses

For an expense to be deductible by the Internal Revenue Service (IRS), it must meet specific criteria: it must be “ordinary,” “necessary,” and “reasonable.” An ordinary expense is one that is common and accepted in a particular industry or type of business. For example, advertising costs are ordinary for most businesses. This does not mean the expense must be habitual or frequent; it simply needs to be a type of expense that businesses in that field would typically incur.

A necessary expense is one that is helpful and appropriate for the business. This does not imply that the expense must be indispensable or absolutely required for the business to operate. For instance, a new software subscription that improves efficiency would be considered necessary even if the business could technically function without it. Finally, a deductible expense must be reasonable in amount, meaning it cannot be extravagant or lavish. The IRS examines whether the amount paid for an expense is justifiable given its purpose and the nature of the business. For example, while taking a prospective client to dinner might be ordinary and necessary, the IRS typically limits the deduction for meals to 50% of the cost. Generally, if an expense meets these three criteria—ordinary, necessary, and reasonable—it can be deducted, provided it is not a capital expense or a personal expense.

Categorizing and Documenting Your LLC’s Expenses

Accurate categorization and meticulous documentation of business expenses are paramount for any LLC. Expenses common to many businesses include office supplies, utilities, rent, professional services, advertising, and insurance. Office supplies encompass items like paper, pens, and printer ink, while utilities include electricity, gas, water, and internet services. Rent paid for office space or other business property is also a deductible expense.

Professional services, such as legal and accounting fees, are typically deductible. Advertising costs, which can range from business cards to online ads, are generally fully deductible. Premiums for various business insurance policies, including liability, property, and workers’ compensation insurance, are also deductible. Vehicle expenses, if a personal vehicle is used for business, can be calculated using either the standard mileage rate or by deducting actual expenses like gas, oil, repairs, and insurance. Travel expenses, including airfare, lodging, and meals incurred while away from home for business, are also deductible, though meals are generally subject to a 50% limitation.

Maintaining accurate records is an IRS requirement. Records must support all income, expenses, and credits reported on tax returns. This documentation should include the amount, date, place, and the business purpose of each expense. For expenses exceeding $75, a receipt is generally required, though for smaller amounts, a detailed written record might suffice. Supporting documents like receipts, invoices, canceled checks, bank statements, and mileage logs are crucial. These records should be organized systematically, perhaps by year and expense type, and kept in a safe place. Electronic accounting software can simplify this process. The IRS recommends keeping business records for at least three years after the tax return’s due date or filing date, whichever is later.

Reporting Business Expenses on Your LLC’s Tax Return

The method for reporting business expenses on an LLC’s tax return depends on how the LLC is classified for tax purposes.

Single-Member LLC

For a single-member LLC, the business is typically taxed as a sole proprietorship by default. Business income and expenses are reported on Schedule C (Form 1040), Profit or Loss From Business. On Schedule C, various expense categories are listed, such as advertising, car and truck expenses, legal and professional services, office expenses, rent, and utilities.

Multi-Member LLC

For a multi-member LLC, the business is generally taxed as a partnership. Partnerships file Form 1065, U.S. Return of Partnership Income. This form reports the partnership’s overall income and expenses. Expenses like salaries, guaranteed payments to partners, repairs, rent, taxes, and interest are reported on specific lines within the deductions section of Form 1065. The partnership itself does not pay income tax; instead, each partner receives a Schedule K-1, which reports their share of the partnership’s income, deductions, and credits, and they then report this on their personal Form 1040.

S-Corporation Election

If an LLC has elected to be taxed as an S-Corporation, it files Form 1120-S, U.S. Income Tax Return for an S Corporation. An S-Corporation reports its income and expenses at the corporate level. Deductions are taken on the Form 1120-S, and then profits and losses are passed through to the shareholders via Schedule K-1, to be reported on their individual tax returns.

C-Corporation Election

For LLCs that elect to be taxed as a C-Corporation, Form 1120, U.S. Corporation Income Tax Return, is used. A C-Corporation is a separate taxable entity, and all business expenses are reported directly on Form 1120 to determine the corporation’s taxable income. Consulting with a tax professional can be beneficial to ensure proper reporting and compliance.

Specific Considerations for LLC Owners

LLC owners face unique considerations regarding certain expenses and their personal tax situations.

Owner Compensation

Owner compensation in an LLC can differ based on its tax classification. For single-member or partnership LLCs, owners typically take “owner draws,” which are distributions of the business’s profits to the owner and not considered a deductible business expense for the LLC. In contrast, if an LLC has elected S-Corporation status, owners who also work for the business are generally required to pay themselves a “reasonable salary,” which is a deductible expense for the LLC. They can then take additional distributions as owner draws.

Home Office Deduction

The home office deduction offers another valuable opportunity for LLC owners. To qualify, a portion of the home must be used exclusively and regularly for business. The home office must also be the principal place of business, or a place where clients or customers regularly meet. LLC owners can calculate this deduction using either the regular method, which involves determining the percentage of the home used for business and deducting a corresponding portion of actual expenses like mortgage interest, rent, utilities, and depreciation, or the simplified method. The simplified method allows a deduction of $5 per square foot for up to 300 square feet of home office space, with a maximum deduction of $1,500.

Self-Employment Taxes

Self-employment taxes are another significant factor. For LLCs taxed as sole proprietorships or partnerships, the net earnings from self-employment are subject to Social Security and Medicare taxes, collectively known as self-employment tax. Deductible business expenses reduce the net earnings, which in turn reduces the amount subject to these taxes. Self-employed individuals can deduct one-half of their self-employment taxes paid from their gross income when calculating their adjusted gross income.

Startup and Organizational Costs

Startup and organizational costs incurred when beginning a new business can often be deducted or amortized. Businesses can elect to deduct up to $5,000 of startup costs and $5,000 of organizational costs in the year the business begins active operations. Any remaining costs beyond the initial deduction can be amortized over a 180-month period, beginning with the month the business starts. These initial expenses can include costs like market research, legal fees for forming the LLC, and advertising before opening.