When you file your business taxes, you may be gathering information and asking yourself what is deductible and not. Income tax deductions benefit your business because they lower your tax bill, and the most common deductions are allowed for businesses. However, some business expenses are not deductible.
Some business expense deductions have been changed since TCJA (Tax Cuts and Jobs Acts 2017).
First of all, to be clear, you can't deduct an expense if you haven't spent the money. You also don't have to deduct an expense if you don't have documentation to prove the expense.
How the IRS Determines Deductible Expenses
The IRS considers a deduction for business expenses if it is ordinary and necessary.
Ordinary expenses are common and accepted in a business or trade. For example, employee uniforms are common in the health care or restaurant industry.
Necessary expenses are useful and appropriate for a business. For example, it helps to have professional consultants, and it is appropriate to pay a certified public accountant (CPA) to help you along the way.
Always non-deductible – no exceptions
Personal Expenses: In general, it is impossible to deduct personal, housing, or family expenses. Even if you have a CPA who files your income tax return linked to the business income tax return, it is considered non-deductible. However, if you have combined expenses, the IRS says you have to split the total cost between the business and the staff and then deduct the business.
Illegal activities: It is a fact, but, for example, you cannot deduct the money you paid for the smuggling of illegal substances into the United States, money laundering, or other illegal activities, such as corruption and bribes.
Taxes, penalties, fines, and certain donations
Federal, state, or local taxes: Federal income tax cannot be deducted. Some states may let you deduct a portion of your federal tax bill. Corporations, as well as partnerships, can deduct state and local income taxes as business expenses. An independent contractor who submits the business tax return with the personal tax return can only deduct state tax if they itemize their return.
Fines and Sanctions: It is impossible to deduct the fine you paid for not estimating taxes last year or the fine for lowering estimated tax penalties. It is also not possible to deduct other fines and penalties related to the federal income tax return. The IRS's most common fines and penalties include failure to file before the due date and late payment.
Political contributions and lobbying: It is impossible to deduct contributions made by your company to a political party or candidate. This includes lobbying fees and campaign participation fees. You can contribute to any qualified charity, and there are ways to deduct charitable donations, but not politics.
Capital and start-up expenses
The IRS considers capital expenditures to acquire long-term assets (such as equipment, buildings, and vehicles) as investments in your business, not expenses. These costs can be further deducted through a process called depreciation, which extends the asset's expense over its useful life.
The costs of starting your business are also investments and are treated as capital expenditures for federal tax purposes. They must be amortized (distributed similarly to amortization) for 15 years.
A limited amount of start-up and organizational costs can be deducted during the first year of operation.
Non-commercial activities
Hobby losses: The IRS says that an activity is a nonprofit hobby, including activities primarily for sports, pleasure, or recreation. If the business is a hobby, it is impossible to deduct expenses to generate losses that exceed the business's income. The general rule of thumb is that a business is considered profitable if it has made a profit for at least three of the last five years, including the current year, but there are many exceptions to this rule. The IRS lists nine factors it uses to differentiate a hobby and a business. Examining these factors can help, but keep in mind that the IRS looks at each situation on a case-by-case basis.
Club Dues: Suppose you belong to a country club, social club, gym, or other clubs. In that case, club dues are not deductible as business expenses, as they are primarily intended for recreational, social, or leisure purposes. Even if you bring customers or clients to this club, the IRS says these expenses are not tax-deductible. You can deduct costs related to a professional business or a business organization directly related to your business. For example, suppose you belong to an industry group or pay commissions for yourself and your employees to your business's professional organization. In that case, those commissions and membership fees may be deductible business expenses. You can also deduct costs from civic groups or public service organizations, as long as their purpose is not primarily social.
Commuting costs: Travel to and from work is common, but the IRS says these transportation costs are not deductible business expenses. If commuting is to get in the car to go to the office and return in the evening, this is not deductible. However, there are some exceptions to this restriction. For example, if you travel from home on business to meet with clients, it is tax-deductible. Or, if you are traveling between commercial sites, it is also tax-deductible.
Business Gift over $25: According to the IRS, you can't deduct more than $25 for corporate gifts you give directly or indirectly to someone during the fiscal year. This includes employees and customers.
Entertainment expenses: The TCJA (Tax Cut and Jobs Act) eliminated the entertainment expense deduction. This means that the cost of entertainment cannot be deducted from customers at sporting events, concerts, or resorts. Business meals at entertainment events are tax-deductible if you can separate the cost of the meal from the entertainment bill. Other meal expenses, including travel meals and certain employee meals, remain deductible, but there are some changes.
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