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Deducting Business Expenses


  • Business expenses are the cost of carrying on a trade or business. These expenses are usually deductible if the business is operated to make a profit.
  • Business expenses must be reasonable.

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 your trade or business.
  • A necessary expense is one that is helpful and appropriate for your trade or business.

Business expenses are separate from the following expenses:

  • The expenses used to figure the cost of goods sold,
  • Capital Expenses, and
  • Personal Expenses.

Cost of Goods Sold

If your business manufactures products 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 figuring the cost of goods sold.

Cost of goods sold is deducted from your gross receipts to figure your gross profit for the year. Following expenses that go into figuring the cost of goods sold:

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

Uniform Capitalization Rules (UNICAP)

  • UNICAP generally requires that all costs incurred (both direct and indirect) in manufacturing or constructing real or personal property, or in purchasing or holding property for sale, must be capitalized as part of the cost of the property.
  • Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs.

This rule does not apply to personal property you acquire for resale if your average annual gross receipts (or those of your predecessor) for the preceding 3 tax years are not more than $10 million.


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. However, you can elect to deduct or amortize certain business start-up costs
  • Business assets
  • Improvements

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.

Example

If you borrow money and use 70% of it for business and the other 30% for a family vacation, you can deduct 70% of the interest as a business expense. The remaining 30% is personal interest and is not deductible,


Business Use of Your Car

  • 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. Standard Mileage rates are to be used, which fluctuate every year.


Other Types of Business Expenses

Employees’ Pay

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

Federal, state, local, and foreign taxes are deductible

Insurance

Ordinary and Necessary cost of insurance is deductible

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