Tax Deductible Business Expenses

Tax deductible expenses are almost any "ordinary, necessary, and reasonable" expenses that help to earn business income. Deductible expenses are those that can be subtracted from a company's income before it is subject to taxation. When it comes to what exactly is meant by ordinary, necessary, and reasonable expenses, the Internal Revenue Service (IRS) has defined these as any expenses that are "helpful and appropriate" for a business. The standard business deductions—which include general and administrative expenses, business-related travel and entertainment, automobile expenses, and employee benefits—are outlined in Section 162 of the Internal Revenue Code. Some expenses are considered "current" and are deducted in the year that they are paid, while others are considered "capitalized" and must be spread out or depreciated over time. There are a few business expenses that are specifically prohibited by law from being deductible, even though they may be used by the business to earn income. These include such things as a bribe paid to a public official, traffic tickets, the clothing one wears for work unless they are a required uniform, and expenditures deemed to be unreasonably large (like a corporate jet for a small retail business to use in visiting a few suppliers).

Good management of a business must include efficient management of the company's tax liabilities, maximizing the deductions and minimizing the obligations within the boundaries of the law. Taking advantage of allowable tax deductions can benefit to small business owners in many ways. "Knowing how to maximize your deductible business expenses lowers your taxable profit," noted Frederick W. Dailey in his book, Tax Savvy for Small Business. "To boot, you may enjoy a personal benefit from a business expenditure—a nice car to drive, a combination business trip/vacation and a retirement savings plan—if you follow the myriad of tax rules." Solid record-keeping is vital for small businesses that hope to claim their allowable tax credits and deductions. After all, deductions can be disallowed for even legitimate business expenditures if those expenditures are not adequately supported by business records. Some of the major categories of tax deductible business expenses are described below:

GENERAL AND ADMINISTRATIVE EXPENSES

All of the basic expenses necessary to run a business are generally tax-deductible, including office rent, salaries, equipment and supplies, telephone and utility costs, legal and accounting services, professional dues, and subscriptions to business publications. Education expenses are deductible if they are necessary to improve or maintain the skills involved in one's present employment or are required by an employer. However, education costs cannot be deducted when they are incurred in order to qualify for a different job. Some other miscellaneous expenses that may be deductible in this category include computer software, charitable contributions, repairs and improvements to business property, bank service charges, consultant fees, postage, and online services.

In most cases, general and administrative business expenses are deductible in the year in which they are incurred. An exception applies to the costs of starting a business, costs that may be incurred prior to beginning operations. These expenses must be capitalized over five years, which may seem strange since they are deductible immediately once the business is open. Depreciating the costs of starting a business might be preferable if the business is expected to show a loss for the first year or two. Otherwise, it may be possible to avoid the need to capitalize these expenses by delaying payment on invoices until the business opens or by doing a trivial amount of business during the startup period.

Home Office Deduction

The use of part of a home as a business office may enable an individual to qualify for significant tax deductions. The "home office deduction" allows individuals who meet certain criteria to deduct a portion of mortgage interest or rent, depreciation of the space used as an office, utility bills, home insurance costs, and cleaning, repairs, and security costs from their federal income taxes. Although IRS has established strict regulations about who qualifies for the deduction, about 1.6 million people claim the deduction each year. The savings that this deduction enables can be considerable, as much as $3,000 annually for a sole proprietor living in a home valued at $150,000.

Home office operators may claim a deduction for those offices on IRS Form 8829 (Expenses for Business Use of Your Home), which is filed along with Schedule C (Profit or Loss From Your Business). There are restrictions, however, which are covered in IRS Publication 587 (Business Use of Your Home). The restrictions were eased somewhat with the passage of the Taxpayer Relief Act of 1997, which will take effect beginning with returns filed in 2000.

In general, a home office deduction is allowed if the home office meets at least one of three criteria: 1) the home office is the principal place of business; 2) the home office is the place where the business owner meets with clients and customers as part of the normal business day; or 3) the place of business is a separate structure on the property, but is not attached to the house or residence. The 1997 changes expanded the definition of "principal place of business" to include a place that is used by the taxpayer for administrative or management activities of the business, provided there is no other fixed location where these activities take place.

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