Deductible Business Expenses
Business expenses are the cost of carrying on a trade or business. These expenses
are usually deductible if the business is operated to make a profit.
What Can I Deduct?
To be deductible, a business expense must be both ordinary and necessary. An ordinary
expense is one that is common and accepted in your trade or business. A necessary
expense is one that is helpful and appropriate for your trade or business. An expense
does not have to be indispensable to be considered necessary.
It is important to separate business expenses from the following expenses:
- The expenses used to figure the cost of goods sold,
- Capital Expenses, and
- Personal Expenses.
Cost of Goods Sold
If your business manufactures products or purchases them for resale, you generally
must value inventory at the beginning and end of each tax year to determine your
cost of goods sold. Some of your expenses may be included in figuring the cost of
goods sold. Cost of goods sold is deducted from your gross receipts to figure your
gross profit for the year. If you include an expense in the cost of goods sold,
you cannot deduct it again as a business expense.
The following are types of expenses that go into figuring the cost of goods sold:
- The cost of product or raw materials, including freight
- Direct labor costs (including contributions to pensions or annuity plans) for workers
who produce the products)
- Factory overhead
Under the uniform capitalization rules, you must capitalize the direct costs and
part of the indirect costs for certain production or resale activities. Indirect
costs include rent, interest, taxes, storage, purchasing, processing, repackaging,
handling, and administrative costs.
This rule does not apply to personal property you acquire for resale if your average
annual gross receipts (or those of your predecessor) for the preceding 3 tax years
are not more than $10 million.
You must capitalize, rather than deduct, some costs. These costs are a part of your
investment in your business and are called capital expenses. Capital expenses are
considered assets in your business. There are, in general, three types of costs
- Business start-up cost (See the note below)
- Business assets
Note: You can elect to deduct or amortize certain business start-up costs.
Personal versus Business Expenses
Generally, you cannot deduct personal, living, or family expenses. However, if you
have an expense for something that is used partly for business and partly for personal
purposes, divide the total cost between the business and personal parts. You can
deduct the business part.
For example, if you borrow money and use 70% of it for business and the other 30%
for a family vacation, you can deduct 70% of the interest as a business expense.
The remaining 30% is personal interest and is not deductible.
Business Use of Your Home
If you use part of your home for business, you may be able to deduct expenses for
the business use of your home. These expenses may include mortgage interest, insurance,
utilities, repairs, and depreciation. Refer to Publication 587, Business Use of
Your Home, and Standard Mileage Rates.
Business Use of Your Car
If you use your car in your business, you can deduct car expenses. If you use your
car for both business and personal purposes, you must divide your expenses based
on actual mileage.
Other Types of Business Expenses
- Employees' Pay - You can generally deduct the pay you give your employees for the
services they perform for your business.
- Retirement Plans - Retirement plans are savings plans that offer you tax advantages
to set aside money for your own, and your employees', retirement.
- Rent Expense - Rent is any amount you pay for the use of property you do not own.
In general, you can deduct rent as an expense only if the rent is for property you
use in your trade or business. If you have or will receive equity in or title to
the property, the rent is not deductible.
- Interest - Business interest expense is an amount charged for the use of money you
borrowed for business activities.
- Taxes - You can deduct various federal, state, local, and foreign taxes directly
attributable to your trade or business as business expenses.
- Insurance - Generally, you can deduct the ordinary and necessary cost of insurance
as a business expense, if it is for your trade, business, or profession.
Source: Internal Revenue Service