Here’s your guide to deducting business expenses. Of course the IRS master guide for this topic is Publication 535 Business Expenses. That’s what any accountant will refer to, since it’s the ultimate source of knowledge for getting business expenses done correctly. Pub 535 is huge, so here we’ll cover the basics of what constitutes a business expense, with a few examples.
Ordinary & Necessary Business Expenses
The IRS uses the terms ordinary and necessary to define expenses that are deductible. Ordinary here means that the expense is to be expected in your line of work. For example, if you run a landscaping business and you purchase nail spa equipment, that’ s a little bit unusual. In fact, it’s very far from ordinary and anyone would have a hard time coming up with a reason why a landscaper would need to do someone’s nails.
Necessary, as defined by the IRS, means it’s an expense that helps your business. It doesn’t actually have to be vital to the business. Now, take that same landscaper. He buys a new rake, that’s an ordinary expense. Totally predictable. But now he buys a worm farm. Kind of unexpected, right? But it makes sense because worms make dirt and process compost. Now that landscaper is supplying his own super rich organic soil, thanks to his worms.
Now, sometimes an expense is ordinary and necessary but you can’t deduct it. That’s because it may be a capital expense. Capital expenses are bigger purchases that you will include in your depreciation form. A new driveway. A van. A new exterior. These are capital expenses.
Or it’s an expense related to maintaining your inventory, if you makes and/or sells things. An example would be the electricity bill, which you included on another portion of your tax return, called Cost of Goods Sold. If you include an expense in that area of your tax return, you can’t also include the expense in your deductions section.
Third reason why an expense might not be deductible on your business taxes is that it’s personal.
Business vs Personal Expenses
The main concern of most taxpayers when they struggle with deductions is determining the difference between a personal expense and a business expense. If the expense is for your family or you personally. For example, if your children use your home office as a playroom, then you can’t deduct total business use of that room on your taxes. If you use that home office once a month, it’s not regular enough to be able to deduct on your business taxes.
When Expenses are Part Business, Part Personal
There’s also that great gray area of expenses that are both personal and business. That is, there are expenses that are for items used partly for business and partly for personal uses. Here we’ll show you the difference with some nice examples so you can do your taxes correctly and not get caught doing something wrong when it comes to deducting your business expenses.