Federal Income Tax Business Deductions

As statutorily specified, a business deduction is a deduction that is an ordinary and necessary expense paid or incurred in carrying on any trade or business. This generally means that one may deduct any reasonable and helpful business expense that they have incurred within the last tax year.

What Types of Things Are NOT Business Deductions?

The following are not business deductions:

• Personal expenses: The gas you put in your car to get to work and even the vehicle you use to get to work are not deductible (unless it is used for business reasons). On the other hand, traveling from work to a meeting for business purposes is an expense that would be deductible.
• Elegant and lavish expenses incurred in businesses: For instance, deductions for entertainment expenses are limited to 50% of the expenses.
• Capital improvements: Investments or anything that could boost profits are not deductible.

What Kinds of Things Are Deductible Business Expenses?

Courts have typically tried to apply the “business deduction” terminology as extensively as possible. A few of the most common business deductions taken by most business taxpayers are the reasonable salary deduction, the travel away from home deduction, the necessary rent deduction, and the costs for education deduction.

What Limitations Are There on the Reasonable Salary Deduction?

In general, a business owner may pay his workers reasonable salaries for their conduct and deduct that amount from his gross income. The IRS only becomes wary of a salary deduction a business owner takes when the salary is disproportionate to the job being conducted. A court will look at incomes for comparable jobs in comparable industries in making its reasonable salary analysis.

What Are the Limitations to the Travel Away from Home Deduction?

The IRS limits this deduction to travels that genuinely are away from home. One must be at least 50 miles from his primary place of business, and one must be gone for a period that would require sleep or rest. Accommodations for business travel are typically 100% deductible, and meals from business travel are typically 50% deductible.

Note: Meal deductions are closely monitored and highly controlled by the IRS as, over the years, many taxpayers have taken liberties with this provision of the tax code.

What Restrictions Are There on the Expenses for Education Deduction?

In general, education expenses that are necessary, practical, and smart in keeping up with one’s career are deductible business expenses. The IRS generally does not allow one to deduct educational expenses incurred in educating oneself about a new career or field but does authorize deductions to continue, improve, or maintain their place in a particular profession.

You must already be in the profession to qualify for the deduction. A nurse or medical student cannot deduct tuition for medical school merely because the nurse or medical student is in a medical profession. After becoming a nurse or medical student, becoming a doctor would be considered a new career.

Are There Any Other Expenses That Can Be Deducted?

Of course! Other than the expenses listed above, businesses can also deduct expenses for:

• Uniforms: Must not be adaptable for general use.
• Advertising: Must not be a capital improvement or political contribution.
• Dues: Must be directly related to business.

What Are Ordinary and Necessary Expenses?

How tax-savvy a businessperson you are dramatically affects how much cash is in your pocket at the end of the year. You likely know that the tax code allows you to deduct costs of doing business from your gross income. What you are left with is your net business profit. This is the amount that gets taxed.

The key to specifying whether an expense is legitimate is found in Section 162 of the tax code, which says that a business expense must be “ordinary and necessary.” Otherwise, it can’t be deducted. Unfortunately, the tax code doesn’t define either ordinary or necessary. Luckily, whether a business expense is ordinary and necessary is evident in many circumstances. For instance, office equipment and supplies used in the business are deductible.

Here are some other ways to determine if an expense is ordinary and necessary:

• IRS publications and rules: In some circumstances, such as travel expenses, the IRS delivers detailed instructions for determining whether or not an expense is ordinary and necessary. This is often done through IRS publications and regulations.
• Court decisions: When there is no direction on whether an expense is ordinary and necessary, it’s up to the courts to reason it out. Typically, courts agree that ordinary and necessary refers to the purpose for which an expense is made. For instance, renting an office room is an ordinary and necessary expense for many companies. However, the space must be used for the business, or the expense won’t qualify. The courts have held ordinary to mean “normal, common, and accepted under the circumstances by the business community.” Necessary has been decoded to mean “appropriate and helpful.”

Given these expansive guidelines, it is not unpredictable that individuals have tried to push the envelope on what qualifies as a business cost; and the IRS has pushed back. Occasionally a settlement is reached, and the matter is sometimes flung into a court’s lap.

Large Expenses

While the tax code contains no “too big” restriction, courts have ruled that it is inherent in Section 162. For instance, it might be reasonable for a large clothing company to rent a jet to travel between manufacturing factories, but not for a corner cafe proprietor to fly to New Jersey to meet with her pickle supplier.

What Are Personal Expenses?

The number one consideration of the IRS when auditing business deductions is whether purely personal expenses are being claimed as business expenses. For example, you can’t deduct the cost of commuting to work because the tax code says this is a personal, not a business, expense.

Because such shenanigans are every day, IRS auditors are ever expectant. Fortunately, you can often organize your matters legally in a way that lets you emanate significant personal benefit and pleasure from business expenditures.

Should I Be Careful When Dealing With Relatives?

An IRS auditor will look suspiciously at payments to a family member or to another business where your relatives have an ownership interest (in tax code terminology, these are known as related parties). An auditor may doubt that taxable profits are being taken out of your company for direct or indirect personal benefit in the mask of deductible expenses. For instance, paying your spouse’s dad, who is in jail, $10,000 as a consultant’s fee for your cafe would smell wrong to an auditor.

Should I Contact a Lawyer Regarding my Federal Income Tax Issue?

With the plethora of tax software out there, most people can do their taxes on their own. More sophisticated and more complex tax returns (i.e., those done by business owners) may require more time and perhaps the advice of a tax attorney. Additionally, if you have a dispute with the taxing authority, you may need to go to court, and a lawyer may be required.

If you find yourself needing a tax lawyer, use LegalMatch to schedule a free consultation with an expert in your area.