Small Business Tax: Capital Gains vs Other Categories

Small business capital gains tax is similar to individual capital gains tax. It is a form of income tax that requires you to pay the Internal Revenue Service a portion of your earnings in a year. These earnings do not include just profits toward your business. You will factor in gains if you have cashed out on investments or property sales as a business. Capital gains is just one of the business tax categories that you will need to be familiar with in order to properly plan for your small business taxes according to Publication 535.

Capital Gains vs. Capital Expense

Capital gains are earnings in a given year that build the equity of your business. Capital expense is the money you paid out in order to build the equity of your business. For example, you may have purchased real estate, machinery or other equity items. If you built your equity through these purchases, you will need to capitalize the expenses instead of deducting the expenses. This means the deduction is taken over a much longer period of time, which is generally beneficial to businesses. However, only a limited amount of expenses can be capitalized, those include:

  • Business start-up costs
  • Business assets
  • Permanent improvements

Start-up costs is perhaps the most nuanced category because it can encompass a wide array of expenses that would otherwise not be able to be capitalized. For example, the cost to recruit new employees can be included in this category. If you improperly capitalize an expense, you are acting illegally, so it is important to ask an accountant for specific direction regarding capital expense versus operating expense.

Capital Expense vs. Cost of Goods Sold

Cost of goods sold is often referred to as operating expense, but the two categories are different. This is the sum of any amount you have spent in order to directly deliver a good to the market. You should note: this does not include marketing expenses or other soft expenses in the budget. It directly applies to:

  • Raw materials
  • Freight
  • Storage
  • Labor for production
  • Factory overhead

A business that is not involved in manufacturing or production may not see many areas in this category it can deduct. In fact, some businesses provide a service, not a good, and will rarely have anything to deduct through itemization of this type. There are still other deductions, however.

Other Deductions

Insurance, rent, interest on loans, real estate taxes and utilities can all be deducted from a small business's taxes in a given year. The main thing to keep in mind is this question: Is this directly a business expense? This can be confusing for small business owners who often mix their personal finances and expenses with business finances and expenses. For example, you may work from home or use your personal vehicle for work. In this case, you have to determine what percentage of usage is dedicated to work and what percentage is dedicated to personal use. This can be confusing to determine, so documenting every calculation is key in order to help avoid an audit in the future.

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