US TAX ADVICE: Tax Incentives and Exemptions for US Tech Businesses
US corporations and individuals are allowed a multitude of different deductions for cash outlays they make throughout the tax year. However, for technology companies and individuals with tech-based hobbies, it can be confusing as to what expenses can be deducted. Below is a brief summary of what can and cannot be deducted for US tech companies and tech-interested individuals.
Capital Expenses
Businesses may deduct all ordinary and necessary business expenses. Capital expenses do not qualify as such. Start up costs, purchase of business assets, and improvements all must be capitalized as assets. However, the company may elect to recover and subsequently deduct more depreciation for tax purposes than is reported for book purposes. This method, called MACRS, allows businesses to deduct the costs of investments more quickly to reduce current tax liability. Read more about how to claim this additional depreciation here.
Additionally, businesses can sometimes deduct most or all of the cost of equipment purchased in the first year it is owned. Many tech companies who frequently purchase new equipment take advantage of this rule, called the section 179 deduction.
Research and Development (R&D)
Research and development expenses are deductible as ordinary and necessary business expenses. The IRS states “R&D expenditures generally include all expenditures incident to the development or improvement of a product”. A product can refer to formulas, patents, processes, or inventions. Expenses that do not qualify as R&D include quality control testing, consumer surveys, and advertising. Businesses can choose to capitalize R&D costs and amortize them over 10 years or deduct the costs in the current year.
Personal Expenses
You cannot deduct personal, living, or family expenses for business purposes. For example, a person who tests video games for their business but also enjoys playing them for fun cannot deduct the whole cost of the games. They may only deduct the bit that is proportional to how often the games are used for business. If they spend 80% of their time testing the games and the other 20% just playing them, they can only deduct 80% of the cost.
Business Use of Car and Home
Those who use part of their home for business may take advantage of the home office deduction. The business owner may deduct some of the costs of owning a home like mortgage interest, utilities, and insurance based on the proportion of the home used for work (calculated by square feet). Similarly, you can deduct the cost of using your car for work. Again, you may only deduct mileage costs for time spent driving for business purposes.
Business vs. Hobby
Some taxpayers might not know if their hobby qualifies as a business or not and if the losses from that business are deductible for tax purposes. For example, someone who plays a lot of video games for fun but also competes in tournaments to win cash may try to deduct any net loss they had from gaming during the year. In order to do this, you must prove to the IRS that you are trying to make a profit. If your activity made a profit in 3 of the last 5 years, it is considered a business and any loss is deductible. If not, the IRS will see it as a hobby and not allow losses to be deducted.