Tax Tip of the Week – Determining Deductible Business Expenses

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Business_expense Every business owner has tons of business expenses that they “need” in order to run their business. And, every business owner believes that everything they spend should be deducted on their tax return. But, the tax code makes reporting these expenses to the IRS tricky. According to the law, some expenses are fully deducted, some expenses are only partially deducted and other expenses are never deductible.

This will be the first in a series on the topic of deductible business expenses. But, let’s start this week with a brief overview on the topic.

So, what is a business expense?

Business Expense – Money spent or cost incurred in an organization's efforts to generate revenue, representing the cost of doing business.

This can be pretty vague. I have heard this one almost a hundred times a tax season, “I need to buy suits for work so that is a business expense.”  Hate to burst your bubble; but, according to the IRS it’s not. As a general rule, nothing is deductible unless you can point to somewhere in the IRS code that states it is.

So, how do you know if something qualifies as a business expense?  In order for an expense to be deductible it must meet the following four categories:

  • The expense is ordinary and necessary for business.
  • The expense is current (in other words for the current year).
  • The expense is directly related to your business.
  • The expense is in reasonable amount

I’ll give you an example of an expense that meets all of the criteria. Your business phone services:

  • You need a phone line for your business to contact customers and for customers to reach your business.
  • The bills you paid during the tax year will be deducted on that year’s tax return. The phone line is only used for business purposes.
  • And hopefully you’re not being ripped off and your bill is a reasonable amount.

Now here is a similar scenario but some of the expenses might not be deductible.  Your cell phone bill:

  • You use your cell phone for business and personal use. We usually estimate what is used for business and personal and use a percentage of what you paid.
  • We can only use what you paid in the tax year so if you paid December’s bill in January what you paid in January will not be used in this tax return but next years
  • Again whatever you use for business is deductible so if you have a family plan you cannot take other family member’s portion of the bill as a business deduction unless they work for you and genuinely use it 100% for business.
  • Last but not least, reasonable amount you have a small, low tech business and you spend $1,500 on a new cell phone, you better be prepared to prove to IRS that is a necessary business expense and is used for business purposes.

In future parts of this series will go into more detail of the four items that a taxpayer must prove in order to deduct a business expense along with examples of expenses that are never deductible.

  Like any good CPA, I need to add a disclaimer: unfortunately, it is impossible to offer comprehensive tax info over the internet, no matter how well researched or written. And remember, I love my readers but having me bookmarked on your computer doesn’t make you a client: before relying on any information given on this site, contact a tax professional to discuss your particular situation.