Tax Cat: Let's Learn About "Necessary And Ordinary Business Expenses"

If you have your own business, you can write off your expenses. This reduces you income, and lowers your tax bill. Sadly, you can’t just write off whatever you want.

Tax Cat sez: You need to follow the IRS’s guidelines and only write off “necessary and ordinary business expenses.”

Here’s the important part of the tax code:

Internal Revenue Code § 162. Trade or business expenses. (a) In general. There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business…

What does this mean?

Well, there are lots and lots of things you may be able to deduct. Here are a few:

  • Office equipment

  • A Home Office
  • Sales tax on business purchases.
  • Professional fees. (This includes tax professionals who’ll do all this crap for you.)
  • Health Insurance premiums
  • Auto expenses.
  • … and more!

Here’s a helpful list. If you have a business expense that isn’t mentioned on the list, that doesn’t necessarily mean you can deduct it.

The Laugh Test

From NOLO.com:taxcatsez.jpg

“Ordinary” has been held by courts to mean “normal, common, and accepted under the circumstances by the business community.” “Necessary” has been taken to mean “appropriate and helpful.”

Given these broad legal guidelines, it is not surprising that some folks have tried to push the envelope on “ordinary and necessary” business expenses, and the IRS has pushed back. Sometimes a compromise is reached, and sometimes the issue is thrown into a court’s lap.

Example

Mr. Henry, an accountant, deducted his yacht expenses, contending that because the boat flew a pennant with the numbers “1040,” it brought him professional recognition and clients. The matter ended up before the tax court. The court ruled that the yacht wasn’t a normal business expense for a tax professional, and so it wasn’t “ordinary” or “necessary.” In short, the yacht expense was personal and thus nondeductible. (Henry v. CIR, 36 TC 879 (1961).)

Tax professionals frequently rely on the “laugh test”: Can you put down an expense for business without laughing about putting one over on the IRS? In the example above, the tax court laughed the accountant and his yacht out of court.

Understanding Small Business Tax Deductions [NOLO]
(Photo:Chad Beckerman)