I work with many business owners and by far, the most commonly asked question I get is, “Can I deduct that as a business expense?” As with all good tax law questions, it depends on a lot of factors — the type of expense, the type of business that you have and whether you can verify the purpose behind the expenses.
Ordinary and necessary
When thinking about any business expense, I like to start with two words —ordinary and necessary. These two words are at the center of how the IRS defines a business expense. But they may not mean what you think they do.
“Ordinary” in this context means the type of expense that a business like yours would normally take. For example, it’s common and accepted for tax preparers to have to pay for software, malpractice insurance and continuing education. Because these are common and accepted in the profession, they are considered ordinary expenses.
However, this point can get very business specific. It’s not ordinary for tax preparers to deduct breast implants as a business deduction. But for entertainers at strip clubs? It’s another story. Thus my tax preparation business wouldn’t be able to deduct that expense, but a stripper at the club in the city might.
The other part of the equation is necessary. I’m still not sure why the IRS uses this particular word since in this case it means “helpful and appropriate” for your trade or business, rather than mandatory or required as one might normally think necessary means. In any case, as long as it’s helpful, you can consider it a business expense.
If your expense fits these two criteria, you are 95% of the way to deduct that expense . However, there are a couple of caveats, which I will discuss later on.
Some common expenses
Industries aside, many businesses deduct a lot of the same type of expenses. Here are some of the common ones.
Travel
You can deduct expenses for traveling away from home for your business. That transportation includes airplanes, trains or automobiles. Additionally, you can expense taxies, Lyfts or Ubers to and from the airport or your hotel and work location. You can also claim baggage and shipping fees, lodging and meals and much more. (See Publication 463 for additional examples.)
The key here is determining your tax home, which is different from your family home. In general, your tax home is your main place of business. If you don't’ have a regular or main place of business due to your type of work, then your tax home is the place where you regularly live. This can get a little complicated, so if you’re at all unsure of your tax home, it’s best to check with your tax professional.
Car expenses
What if you travel primarily by car? This expense occurs often enough that Iwant to give it its own consideration. As with other travel expenses, you mustbe traveling for business. Additionally, you can’t deduct ordinary commuting from your family home to your place of business. You can deduct your actual expenses (gas, repairs, maintenance) or take the standard deduction, which is based on the miles that you drive (which is 58 cents/mile for 2019). You can also include tolls, parking and also rental cars that are used for business.
If you’re taking this expense for the first time, note that if you take actual expenses your first year, you’re stuck with taking actual expenses for the life of your vehicle. However, if you take the standard deduction your first year, you’re allowed to switch back and forth. (Yet another weird intricacy in the world of the IRS.)
Business use of home
Deducting a home office is another area where a two-word phrase comes in handy — exclusively and regularly. The space has to be used exclusively as a business space and regularly. Unlike “ordinary and necessary,” these words mean exactly you think they do. The space just has to be an office space and it has to be space that you use regularly. You can find more detail about this deduction here.
Some other commons ones:
- Employee and contractor pay — You can deduct what you pay for people that help you in your venture, whether they are a W-2 employees or independent contractors.
- Insurance — You can deduct insurance that is necessary for your job, such as liability, E&O insurance or essential employee insurance. However, you can’t deduct disability insurance for lost wages. That’s a personal expense, not a business expense (more on this later).
- Retirement plans — Contributions to retirement plans like solo 401ks, SEPs or SIMPLE IRAs are deductible, whether you’re contributing on your own behalf or for your employees.
- Office expenses — Save your receipts for software, pencils, paper, tissue etc. You can deduct any of these supplies from your bottom line.
- Interest and fees — If you’re paying interest and fees on money that you borrowed you can deduct that too.
Those are just the most common business expenses. There are lots of others. If you’re starting a business for the first time, I suggest looking over a Schedule C and reading the instructions to get a sense of what you can and can’t take.
Some pitfalls to avoid
So far, you’re probably thinking that deducting business expenses is easy. But there are some issues that can cause huge problems. Here are three important pitfalls to avoid when thinking about deducting business expenses.
You have to have a business
I know this may sound a bit obvious, but it’s not so far fetched for people to try to take business expenses while not having a business. In fact, before the Tax Cuts and Jobs Act, you could deduct some work-related expenses even as an employee. That deduction is gone for the time being, but it may come back after 2025.
For the most part, the IRS focuses on intent when considering whether something is a business venture. It looks at many factors such as:
- Do you put in the necessary time and effort to turn a profit?
- Do you have the necessary knowledge to succeed in this field?
- Do you depend on income from this activity?
- Have you made a profit in this activity in the past, or can you expect to make one in the future?
The IRS presumes that your activity is a hobby rather than a business if it hasn’t made a profit in three of the last five years (this is known as the hobby-loss rule). The presumption can be overcome, but if it’s not, all of the losses of the hobby will be capped at the hobby income.
You can’t take personal expenses
Even if you have a business, you still can’t deduct any type of personal expense. These expenses include any type of personal, living or family expenses. For example, while childcare is likely common and helpful for any business, it’s considered a personal expense and non-deductible. The same goes with the premiums you pay for your disability and life insurance that I mentioned above.
If you have an expense — say travel or utilities — that is both business and personal, the IRS asks that you divide the costs within personal and business parts. So if you are using your cell phone for business and personal calls, you can split it between what you reasonably think could be business use and personal use (say 70/30).
Some expenses you can’t deduct all at once
There are some expenses that you can’t deduct all at once because they are what the IRS considers capital expenses. You’re investing in your business when you buy furniture, computers, buildings or other large items. You’re also making a long-term investment when you cover start-up costs and improvements on your business facility. Because you’ll use them over multiple years, the IRS asks you to spread your deduction for them over multiple years as well.
As a result, these expenses are taken over a specific amount of years, depending on the type of expense. Remember those breast implants I mentioned? Those had to be depreciated. If you have questions about this, make sure to ask your tax preparer to go over your depreciation schedule with you.
I hope you’ve found this summary helpful. As always, it’s best to make sure to learn the fundamentals and then seek out trusted advisors to help you navigate the details.
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