Posted on: 16 November 2020Share
The ability to deduct business expenses is one of the biggest means of reducing your business's tax bill. But not everything you or your company pays for is deductible. Each expense must pass a few key tests before they are legitimate tax deductions. What are some of these tests? Here are three of the most common and most important.
1. The Expense Must Not Be Disallowed
First, some categories of business expenditures are explicitly stated as not being allowed by the IRS rules. While you may deduct most of the ordinary taxes paid, including excise taxes and payroll taxes, any kind of penalty tax is explicitly prohibited as a deduction. If it's included with other taxes on a form, you would need to remove it before claiming the appropriate ones.
Businesses should keep up with changes in the tax laws as to what's disallowed and what may be reinstated. During recent tax reform, for instance, entertainment expenses have been disallowed as a deduction for a period of time. This change may affect how you handle these expenses.
2. The Expense Must Be Ordinary
When it describes allowable expenses, the IRS stipulates that the expense must be "ordinary." This doesn't refer to its size, schedule, or unusual nature but rather to how common it is for businesses like yours.
Whether or not something is ordinary varies by business. A microbrewery might spend a lot of time sampling beers and traveling for competitions, just like their competitors. But a veterinarian would likely not be able to deduct the same trips as "ordinary" in their industry.
3. The Expense Must Be Necessary
Finally, the expense must also be considered necessary for your business. Essentially, it must maintain or further your business in some way. Those beer trips may help the brewery network with other producers, find new ingredients, or win prizes. The veterinarian, on the other hand, may deduct the cost of dog toys as a necessary expense to help provide better pet care.
Keep in mind that the expense doesn't actually have to succeed in furthering your business in order to be deductible. If the brewery failed to find any workable new flavors on their trip, many expenses related to it may still qualify for the purpose they were made.
Where To Learn More
Many business expenses may fit into a deductible category, but it's risky to assume so. The best person to tell you whether or not something may be deducted is a tax preparer. They can help you assess costs and build a solid paper trail if anything may raise questions by the tax agencies. Learn more by meeting with a tax preparation service in your state today.