Business Tax Deductions

Ordinary and Necessary Expenses

The Internal Revenue Service (IRS) states that “there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business,” though it does not specifically define either “ordinary” or “necessary.” While there are hundreds of rules and legal precedents about certain kinds of deductions, probably the best test is the informal “laugh out loud rule.” An actor or actress, for example, would probably be able to deduct the cost of cosmetics worn during auditions and public appearances, or even cosmetic surgery, as an ordinary expense, but a freelance engineer would probably not be able to claim that because that chin job makes him or her more confident, it improves his or her work, therefore should be a business tax deduction.

Depreciation

Certain business tax deductions are subject to depreciation. In other words, they must be spread over a certain period of time. These are usually large capital expenses, such as equipment. Different categories of equipment, such as computers and furniture, have different depreciation schedules; check with the IRS to make sure.

Personal Expenses

The IRS specifically disallows deducting personal expenses as business tax deductions. If you buy a laptop and primarily use it for personal use with the occasional business use, it is not likely to be deductible. However, the cost of business software that you use only for business is likely to be deductible.

It also usually disallows business expenses that are disproportionately high because of personal convenience or self-indulgence. For example, if you are traveling from the United States to the Caribbean to meet with suppliers located in the Caribbean, airline tickets are likely to be a deductible expense, but taking a cruise from the US there and back would not be, unless the cruise is actually more affordable than regular airline tickets would be. (Be sure to document it.)

You can combine business and pleasure, though. For example, if you take a few days to vacation after your meeting, it doesn't mean that the trip isn't a deductible expense; you just can't deduct the hotel and other expenses for those few days.

Common Business Tax Deductions

Startup Expenses

Virtually all ordinary and reasonable expenses in starting a business are deductible. A certain amount (currently $5,000) can be deducted during the first year, while other costs must be depreciated over the next fifteen years.

Home Offices

Home office expenses are one of the most common areas for abuse and the IRS has very strict rules about the definition of a home office. It must be an area dedicated solely to business use and the amount of space dedicated to business use must be reasonable. A freelance photographer, for example, would probably be able to deduct a home darkroom but unless he or she uses the second bedroom just for photo shoots and equipment storage and for nothing else, occasional use of that bedroom for shoots or storage would probably not make it deductible.

Educational Expenses

Educational expenses that are not reimbursed (or are only partially reimbursed) by your employer are usually tax deductible, but only if they are related to your current job. They are not valid business tax deductions if they would prepare you to start a new career. For example, a chef could deduct the cost of a course in pastry decoration, but if you aren't in the food business, you can't deduct the course even if you plan to start a catering business. Educational expenses can also cover books as well as formal classes.

Auto Expenses

If you use your car for business and are not reimbursed by your employer (or are self-employed), you likely can deduct mileage expenses. The IRS allows for a standard cost per mile or you can deduct actual costs. However, car repairs or maintenance are much trickier and are rarely deductible unless you can prove that if it weren't for your business, you wouldn't have incurred the expense.

Professional Services

Fees paid to a professional, either an individual or a firm, can be business tax deductions. However, they must be legitimate professionals doing a legitimate business service. If you wish to hire a relative or even a friend, you must be sure that he or she is qualified and that the fees you pay are reasonable. A good rule of thumb is whether or not a business that didn't have that personal connection would hire your friend or relative and would pay them the same amount.

In Conclusion

This article refers to the United States only. As with any tax information, this articles is meant to inform you of potential tax deductions and is not tax advice. Only a tax professional can look at your unique business situation and provide the best advice.