What Can I Deduct for my Business?

I get this question all the time. Based on guidance from the IRS, here is a good answer to the age old "What Can I deduct or What kind of expenses are deductible in my small business?"

Business expenses are the cost of carrying on (operating) your business. These expenses are usually deductible if the business is operated to make a profit. If your business never makes any profit, it may be a hobby and unfortunately hobby expenses are not deductible.

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 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. In other words, you use and expense the Internet at your office, but you could conduct business without it, although, it would take you back to the 19th century. Another example would be, business meals. They may be necessary depending on your line of work but may not be indispensable.

It is important to separate business expenses from the following expenses:

The expenses used to figure the cost of goods sold (Common in Businesses with Inventory as well as others), Capital Expenses, and Personal Expenses (Not Deductible).

Cost of Goods Sold

If your business manufactures products / items 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 calculating cost of goods sold. Cost of goods sold is deducted from your gross sales 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; no double dipping. Inventory is complicated and requires your the taxpayer to keep detailed records of all purchases as well as which items were sold during the year.

Some Examples of the Types of expenses that go into figuring the cost of goods sold.

The cost of products or raw materials, including shipping & Storage, labor costs (including contributions to pensions or annuity plans) for workers who produce the products, Factory overhead.

Capital Expenses

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 you capitalize.

Business start-up cost (See the note below)
Business assets
Improvements

Capital assets are written off over time via depreciation or amortization. Depending on the asset type, you may be able to elect a Section 179 deduction, subject to certain limitations.

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 80% of it for business and the other 20% for a family vacation, you can deduct 80% of the interest as a business expense. The remaining 20% 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.

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. Keep accurate records such as a daily travel log so you can provide substantive evidence in case of an audit or IRS examination.

Other Types of Business Expenses

Wages - 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.
See my blog for details on how to correctly deduct health insurance for S-corporations.