If you own or operate your own business, the IRS allows you to deduct certain expenses related to your business. The IRS has a specific definition about what expenses you can deduct.
In order to deduct a business expense, the expense must be both ordinary and necessary. According to the IRS, 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. An expense does not have to be indispensable to be considered necessary.”
The IRS does not provide a comprehensive list of expenses that are both ordinary and necessary. Instead, the IRS leaves it to each taxpayer to determine what expenses are both ordinary and necessary for the taxpayer’s business.
While any given business may have unique characteristics that distinguish it from all other businesses, there are common types of expenses that are generally considered to be ordinary and necessary. Following are some of the more common ordinary and necessary business expenses that the IRS commonly allows taxpayers to deduct.
Cost of Goods Sold
Businesses that produce a product for sale to others will incur costs associated with the production of those goods. These costs are commonly known as cost of goods sold. For such a business, cost of goods sold is considered an ordinary and necessary expense of the business.
Cost of goods sold typically includes the following costs:
- The cost to purchase the raw materials necessary to produce the good and to have those materials transported to where the business will use them to product the good.
- The cost to store the raw materials used in the product as well as the final product until the time it is sold and shipment to the customer.
- The cost of labor used to assemble the raw materials into the final product.
- Other costs associated with running the factory that produces the goods that may not directly contribute to production of the good.
Depreciation on Capitalized Business Assets
Capitalized business assets refer to certain property used in the course of running the business. Example of this property includes buildings, machinery, vehicles, and furniture.
The IRS deems each type of capital asset to have a useful life. The value of the asset depreciates over its useful life. Therefore, the business may deduct the fraction of that asset applicable to the current business year.
In order to deduct depreciation of a capital asset, the business must own those assets. For example, if the business is renting the building where it conducts business, the business cannot deduct depreciation on the building.
The IRS does not allow a business to deduct the costs associated with personal assets. However, if a personal asset is legitimately used in part for the good of the business, the business can deduct the costs associated with the business usage.
Typically, the taxpayer will define what percent of the usage is attributable to the business and allow the business to deduct that percent of the expense. This rule applies to business use of personal homes, vehicles, or other assets.
Other Business Expenses
The above is only a partial list of common expenses that taxpayers can deduct for their business. Other expenses that a taxpayer can deduct include salary expenses, retirement plan expenses, insurance expenses, and certain taxes.
A taxpayer should consult a tax attorney when determining the expenses that could reasonably be considered ordinary and necessary for his or her business.
Assistance from a Tax Attorney
If you need to speak with a tax attorney, you can do so by calling the phone number located at the top of this web site. A tax attorney who is familiar with self employment laws and taxes will speak with you about your specific situation.
The initial conversation is free of charge and does not obligate you to anything further. Therefore, you have every reason to make the call today.
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Mark has been a contributor to legal web sites related to bankruptcy, tax, and criminal law since 2011. He has an Accounting degree from Texas A&M University.