Deductible Business Expenses

Every company or individual entrepreneur incurs expenses of carrying out business activities. These costs and expenses can usually be deducted from the overall profits. An expense can be deducted if it is both 1) ordinary for a particular type of commercial activity and 2) necessary for the business.


Basically most of the expenses incurred in the business operations can be deducted. However, the percentage of the allowed deductions can vary. For example, only 50% of the meals and entertainment expenses can de deducted while a cost of goods sold is a 100% deductible. Business owners must keep records of every expense they incur and review it with the accountant in the end of the year.

 

Having said that most of the business expenses can be deducted, it helps to separate them in the following major categories:

 

1. Cost of Goods Sold

 

If a company manufactures and sells tangible products, the cost directly incurred to produce those items is considered Cost of Goods Sold. The company must conduct valuation of its inventory at the beginning and the end of each tax year in order to determine the cost of goods being sold.


Cost of Goods Sold may consist of the following expenses:

 

                   The costs of products and raw materials

                   Storage

                   Direct labor costs that are salaries and benefits of the workers who produce the goods for sale

                   Factory overhead

 

A business must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs are all examples of indirect costs.

 

2. Capital Expenses

 

A business must capitalize, rather than deduct some expenses. Capital Expenses are funds invested in the business. The following are usually considered business assets:

 

                   Business start-up costs.

                   Acquisition of new assets

                   Improvements to the already existing assets

 

Please keep in mind that in some cases a company can elect whether to deduct or amortize certain business start-up costs

 

Personal vs. Business Expenses:

 

Personal expenses such as living costs cannot be deducted. Nevertheless, if the expenses were incurred for both the business and personal purposes, then the total cost should be divided respectively. Only a part of the expense, which is attributable to business purposes, can be deducted.

 

3. Business Use of Home:

 

If a personal home is used for business, expenses proportionate to the part of the home, which is used exclusively, regularly, and predominantly for business activities, can be deducted. For example, if a person has a home office, the utility bills can be prorated in accordance with the square footage that office occupies, and only a part of the costs that covers the home office area can be deducted, not the whole bill. The same principle applies to every expense that may be relevant to the house/apartment/other type of dwelling.

 

4.  Business Use of car:


When a car is used for business, all associated expenses (gas, tools, parking, etc.) can be deducted. If a car is used for both the business and personal purposes, the expenses must be divided based on the actual mileage. There are two methods to determine deducible portion of the car expenses:

 

a) Standard mileage rate        b) Actual car expenses

 

5.  Travel:


Travel expenses may be deducted only if traveling is ordinary and necessary activity for the business.  The following is included in the traveling costs:

 

·                    Transportation by airplane, train, bus, or car between home and business destination.

·                 Taxi, commuter bus, airport limousine and fares of other transportation that transports a person between:  a) an airport or a station and a hotel, and b) a hotel and work location of the customers/clients, business meeting place, or a person’s temporary work location

·                    Baggage and shipping when sending baggage and samples of the materials between a regular and temporary work locations.

·                    Operation and maintenance of a personal car while traveling away from home for business. If a rental car is used instead of a personal one, only business-use portion of the expenses can be deducted.

·                    Lodging and Meals

·                    Dry cleaning and laundry while on a trip.

·                    Telephone use for business calls during the trip. This includes business communication by fax machine or other communication devices.

·                    Tips paid for any expenses mentioned above. 

·                    Other- other similar ordinary and necessary expenses related to the business travel

 

6. Entertainment & Gift Expenses:

 

Entertainment expenses can only be deducted if they are both ordinary and necessary and meet one of the required tests. Generally, a deduction of business-related meals and entertainment expenses is subject to a 50% limit. These expenses may be incurred when entertaining a client, customer, or employee, for example.


The cost of the gifts that are given in the course of the business can be deducted in whole or in part depending on the cost of the gift. No more than $25 value of the gifts can be given directly or indirectly to the same person during the tax year.

 

7. Other Business Expenses:

 

                   Employees’ Pay – actual compensation for the services people provided for the company

                   Employees’ Benefit Plans, including retirement plans, pension plans, savings accounts, insurance plans.

                   Rent Expense – if a company owns the property, rent cannot be charged and deducted, but rather depreciation of the property value over a period of time can be deducted. 

                   Interest – the amount charged for the use of money borrowed for business activities, including mortgage interest if a real property is owned.

                   Taxes – multiple federal, state, local, and foreign taxes that are attributable to the business activities

                   Insurance costs

                   Accounting, legal and other professional advisers’ fees

                   Advertising and marketing

                   Amortization

                   Bad debt a company cannot collect

                   Bank fees

                   Business associations’ membership dues

                   Continuing education and training of personnel

                   Depreciation

                   License fees

                   Office supplies

                   Outside services

                   Repairs and utilities

 

For additional information, please refer to IRS Publication 535, Business Expenses.

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