Business Expense & Tax Deductions – A Complete Guide on Business Expenses For Tax Deductions

You are about the “crack the code” on business expenses and tax deductions.  Following this simple-to-follow and easy-to-implement information will help you get the most out of your tax deductions.

The expenses to run a trade or business are business expenses. Rent, payroll, advertising, repairs, interest, depreciation, taxes, etc. are few examples of business expenses. If the business is run to make profit and the expenses are ordinary and necessary, then these expenses qualify as deductible business expenses. Payroll expense is commonly accepted expense for most businesses and therefore it is deductible business expense.

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It is necessary to distinguish the business expenses from cost of goods sold, capital expenses, and personal expenses because these expenses have special rules to decide how to figure out these expenses, and how much can be treated as deductible business expenses for a particular tax year. Let us review these expenses with some more details.

Cost of Goods Sold:

If you are in manufacturing or resale business, you need to value your inventory at the beginning and end of tax year to determine your cost of goods sold. Cost of raw materials, freight, storage, direct labor, factory overheads are the type of expenses that go into figuring cost of goods sold. Cost of goods sold is deducted from gross receipts to figure out gross profit. The expenses allocated to figure out cost of goods sold, cannot be claimed again as business expense.

For more information about tax aspects of cost of goods sold, please refer to chapter 6 of IRS Publication 334. Please refer to IRS Publication 538 on inventories.

Capital Expenses:

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Capital expenses are the part of your investment in the business. Business start up costs, business assets, and improvement costs are the main types of capital expenses. Capital expenses are considered assets of business and generally their benefits are available for period more than a year.  You must capitalize, rather than deduct these expenses. You may be able to recover this expense through depreciation, amortization, or depletion. These recovery methods allow you to deduct part of your cost each year.

Business start up costs: You can elect to deduct or amortize certain business start up expenses. For more information, please refer to Chapter 7 and 8 of IRS Publication 535. Advertizing, travel, and training are the examples of business start up costs.

What if your attempt to get into business fails? In that case, the costs you had before making a decision to acquire or begin a specific business are your personal and non-deductible expenses. The expenses for search or investigation of a business or investment possibility are examples of this kind of expenses. The costs you had after making a decision to attempt to acquire or begin a specific business are capital expenses and you can deduct them as capital loss.

Business Assets:  Land, buildings, machinery, furniture, trucks, franchise rights, and patents are examples of business assets. You must fully capitalize these assets.

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Improvements: Improvements are capital expenses if they increase the general value, or the utility value and life of the asset.  New electrical wiring, lighting improvements, structural improvements etc. are examples of Improvements that can be treated as capital expense. However the repairs intended to keep the machinery in normal operation is not capital expense and you can deduct these repairs as normal business expenses.

Personal Expenses:

While recording an expense transaction in books of business, it is important to make sure that it is not personal, living, or family expenses as these are not deductible business expenses. However, if you have an expense that is used partly for personal and partly for business purpose, divide the total cost between the personal and business part. You can deduct the business part of the cost.

Business use of home and car are examples of personal expenses that can be partly treated as business expenses. You need to be very cautious and precise in treating personal expenses as business expenses as this is the area which might trigger tax audit.

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If the deductible business expenses are more than income, you have a loss. There may be limits on how much of the loss you can deduct. Not-for-profits limits, At-risk limits, Passive activities etc. are some limits that decide deductible loss. Net operating loss can be used to lower taxes in other years.