Every purchase you make for a legitimate business expense may be tax-deductible. This includes even the smallest purchases, like pens and paper. It also includes larger purchases, such as office buildings and company cars. By understanding which business tax deductions are allowed and keeping track of all those seemingly small purchases, you could reduce your taxes.
The Internal Revenue Code allows you to deduct all "ordinary and necessary" expenses of operating your business. These deductions vary from business to business.
According to the IRS, any small business deductions you claim on your tax return have to be ordinary and necessary. The IRS interprets "ordinary and necessary" to mean reasonable (routine strategy to generate business) and customary (typical practice for your line of business). What does this mean for you, the taxpayer? That depends on which line of business you are in and the business customs of your specific industry. The following examples show what the IRS will consider ordinary and necessary.
Sam
Sam owns an auto repair shop in a small town. He tries to deduct as many business expenses from his taxes as possible. In preparing his taxes, Sam reports his first year's business income to be $22,000. He deducts all the ongoing costs of doing business such as utilities, office supplies, advertising, shipping, and telephone charges, as well as $4,360 for a client entertainment expense.
The deduction of Sam's ongoing costs of doing business would be considered ordinary and necessary: The IRS would most likely agree that not only is such a deduction necessary, but also customary for the taxpayer's line of business.
As for the entertainment expense, although Sam believes that this was a necessary expense-since he expects the money he has spent on business lunches for potential clients will pay off in the long term by providing him with a thankful, loyal customer base-the IRS would probably disallow these small business deductions.
The entertainment deduction would not be considered ordinary and necessary: The IRS would argue that it is not customary for auto repair shop owners to treat their potential clients to expensive lunches and dinners.
Before claiming small business deductions, ask yourself two key questions:
- "Are these small business deductions necessary expenses of doing business, i.e. how will they help my business increase its income?"
- "Are these small business deductions customary for my line of business?"
Click here for the most common tax write-offs taken by small businesses. (Requires Adobe Acrobat Reader) Check with your tax advisor to see if there are additional deductions you can take.
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