As you complete your business taxes, you may be gathering information and wondering what is deductible and what is not. Business tax deductions benefit your business because they cut your tax bill, and most common deductions are allowable to businesses. However, some business expenses are nondeductible.
Some business expense deductions have changed since the 2017 Tax Cuts and Jobs Act, so check this list carefully for changes.
First, to be clear, you can't deduct an expense if you didn't spend the money. Also, you shouldn't deduct an expense if you don't have the records to show the expense.
How the IRS Determines Deductible Expenses
The IRS considers a business expense to be deductible if it is both ordinary and necessary.
Ordinary expenses are those that are common and accepted in a trade or business. For example, expenses for employee uniforms are common in the restaurant industry or in health care.
Necessary expenses are helpful and appropriate for a business. For example, it's helpful to have professional advisors and appropriate to pay a certified public accountant (CPA) to do your business taxes.
Always Nondeductible - No Exceptions
You generally can't deduct personal, living, or family expenses. Even if you have a CPA do your personal tax return that's connected to your business tax report, it is considered nondeductible. However, if you have a combined expense, the IRS says you should divide the total cost between the business and personal and then deduct the business part.
This is a given, but for example, you can't deduct money you paid for smuggling illegal substances into the U.S., for money laundering, or other illegal activities, like bribes and kickbacks.
Taxes, Fines, Penalties, and Certain Donations
Federal, State, or Local Taxes
You cannot deduct federal income taxes. Some states may allow you to deduct a portion of your federal tax bill. Corporations and partnerships can deduct state and local income taxes as business expenses. A self-employed business owner filing their business tax return with their personal return can deduct a state tax only if they can itemize deductions.
Fines and Penalties
You can't deduct the fine you paid for not estimating your taxes last year or the penalty for underpayment of estimated tax penalties. You also cannot deduct any other fines and penalties related to your federal tax return. The most common fines and penalties imposed by the IRS include failure to file by the due date and late payment.
Political Contributions and Lobbying Expenses
You can't deduct contributions your business made to a political party or to a candidate. This includes lobbying costs and the costs of attending campaign events. You may contribute to any qualified charity, and there are ways to deduct charitable contributions, but not political ones.
Capital Expenses and Startup Expenses
The IRS considers capital expenses for buying long-term business assets (like equipment, buildings, and vehicles) as investments in your business, not expenses. These costs can still be deducted by a process called depreciation, which extends the expense for the asset over its lifetime.
Costs for starting your business are also investments, and are treated for federal tax purposes as capital expenses. They must be amortized (spread out in a similar way to depreciation) over 15 years.
You may be able to deduct a limited amount of startup and organizational costs in the first year of your business.
The IRS says an activity is a hobby if it is not done for profit, including activities done mainly for sport, recreation, or pleasure.
If the activity is a hobby, you can't deduct expenses to create losses greater than the business income. The general "rule of thumb" is that an activity is assumed to be for profit if it made a profit in at least three of the last five tax years, including the current year, but there are many exceptions to this rule.
The IRS lists nine factors it uses to distinguish between a hobby and a business. Reviewing these factors might be helpful to you, but note that the IRS considers each situation on a case-by-case basis.
If you belong to a country club, social club, fitness facility, or other clubs, your club dues are not deductible as a business expense because they are carried out primarily for pleasure, recreation, or social purposes. Even if you take clients or customers to this club, the IRS says these expenses are not deductible.
You can deduct costs related to a professional business or trade organization directly related to your business. For example, if you are in an industry group or you pay dues for you and your employees to a professional organization that relates to your business, these dues, and any membership expenses, can be deductible business expenses.
You can also deduct costs for civic groups (like Lions or Optimists) or public service organizations, as long as their purpose isn't primarily social.
Traveling from home to work is commonplace, but the IRS says these commuting costs are not deductible business expenses. If your travel is to get in your car to go to your office and come back at night, that's not deductible.
There are some exceptions to this restriction, however. For example, if you travel for business from home to meet customers, that is deductible. Or, if you travel between business locations, that's also deductible.
Business Gifts Over $25
According to the IRS, you can deduct no more than $25 for business gifts you give directly or indirectly to any one person during your tax year. This includes both employees and customers.
The 2017 Tax Cuts and Jobs Act has eliminated the deduction for entertainment expenses. This means you can't deduct the cost of entertaining clients at sporting events, concerts, or resorts. Business meals at entertainment events are deductible if you can separate the meal cost from the entertainment bill. Other meal costs, including meals while traveling and some meals for employees, are still deductible, but there are some changes.
Frequently Asked Questions
How can I claim business expenses on my tax return?
To claim business expenses for most small businesses, you will need to complete a business tax report as part of your personal tax return. The type of report varies depending on your business type.
How can I get more information on what's deductible and what's not?
IRS Publication 535 has details on business tax deductions, including limitations and qualifications.
When is my business tax return due?
Most small business tax returns are due on April 15 of the following year, because they are filed with the owner's personal tax return. Partnership and corporation return due dates vary depending on the company's year-end. The specific date for tax returns changes each year because of weekends and holidays