Table of Contents
- Introduction
- Useful Items - You may want to see:
- Bad Debts
- Car and Truck Expenses
- Depreciation
- Employees' Pay
- Insurance
- Interest
- Legal and Professional Fees
- Pension Plans
- Rent Expense
- Taxes
- Travel, Meals, and Entertainment
- Business Use of Your Home
- Other Expenses You Can Deduct
- Expenses You Cannot Deduct
You can deduct the costs of running your business. These costs are known as business expenses. These are costs you do not have to capitalize or include in the cost of goods sold.
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be indispensable to be considered necessary.
For more information about the general rules for deducting business expenses, see chapter 1 in Publication 535, Business Expenses.
Publication
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463 Travel, Entertainment, Gift, and Car Expenses
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535 Business Expenses
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946 How To Depreciate Property
See chapter 12 for information about getting publications and forms.
If someone owes you money you cannot collect, you have a bad debt. There are two kinds of bad debts, business bad debts and nonbusiness bad debts.
A business bad debt is generally one that comes from operating your trade or business. You may be able to deduct business bad debts as an expense on your business tax return.
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Created or acquired in your business.
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Closely related to your business when it became partly or totally worthless.
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If you use your car or truck in your business, you may be able to deduct the costs of operating and maintaining your vehicle. You also may be able to deduct other costs of local transportation and traveling away from home overnight on business.
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Getting from one workplace to another in the course of your business or profession when you are traveling within the city or general area that is your tax home. Tax home is defined later.
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Visiting clients or customers.
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Going to a business meeting away from your regular workplace.
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Getting from your home to a temporary workplace when you have one or more regular places of work. These temporary workplaces can be either within the area of your tax home or outside that area.
Example.
You operate a printing business out of rented office space. You use your van to deliver completed jobs to your customers. You can deduct the cost of round-trip transportation between your customers and your print shop.
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Example.
You are a graphics designer. You operate your business out of your home. Your home qualifies as your principal place of business. You occasionally have to drive to your clients to deliver your completed work. You can deduct the cost of the round-trip transportation between your home and your clients.
For local transportation or overnight travel by car or truck, you generally can use one of the following methods to figure your expenses.
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Standard mileage rate.
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Actual expenses.
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Use the car for hire (such as a taxi),
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Operate five or more cars at the same time,
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Claimed a depreciation deduction using any method other than straight line, for example, ACRS or MACRS,
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Claimed a section 179 deduction on the car,
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Claimed the special depreciation allowance on the car,
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Claimed actual car expenses for a car you leased, or
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Are a rural mail carrier who received a qualified reimbursement.
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You generally can deduct the amount you reimburse your employees for car and truck expenses. The reimbursement you deduct and the manner in which you deduct it depend in part on whether you reimburse the expenses under an accountable plan or a nonaccountable plan. For details, see chapter 11 in Publication 535. That chapter explains accountable and nonaccountable plans and tells you whether to report the reimbursement on your employee's Form W-2, Wage and Tax Statement.
If property you acquire to use in your business is expected to last more than one year, you generally cannot deduct the entire cost as a business expense in the year you acquire it. You must spread the cost over more than one tax year and deduct part of it each year on Schedule C. This method of deducting the cost of business property is called depreciation.
The discussion here is brief. You will find more information about depreciation in Publication 946.
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It must be property you own.
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It must be used in business or held to produce income. You never can depreciate inventory (explained in chapter 2) because it is not held for use in your business.
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It must have a useful life that extends substantially beyond the year it is placed in service.
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It must have a determinable useful life, which means that it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes. You never can depreciate the cost of land because land does not wear out, become obsolete, or get used up.
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It must not be excepted property. This includes property placed in service and disposed of in the same year.
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Most passenger automobiles.
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Most other property used for transportation.
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Any property of a type generally used for entertainment, recreation, or amusement.
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Certain computers and related peripheral equipment.
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Any cellular telephone (or similar telecommunications equipment).
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Depreciation on property placed in service during the current tax year.
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A section 179 deduction.
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Depreciation on any listed property (regardless of when it was placed in service).
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You can generally deduct on Schedule C the pay you give your employees for the services they perform for your business. The pay may be in cash, property, or services.
To be deductible, your employees' pay must be an ordinary and necessary expense and you must pay or incur it in the tax year. In addition, the pay must meet both the following tests.
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The pay must be reasonable.
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The pay must be for services performed.
Chapter 2 in Publication 535 explains and defines these requirements.
You cannot deduct your own salary or any personal withdrawals you make from your business. As a sole proprietor, you are not an employee of the business.
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Awards.
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Bonuses.
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Education expenses.
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Fringe benefits (discussed later).
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Loans or advances you do not expect the employee to repay if they are for personal services actually performed.
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Property you transfer to an employee as payment for services.
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Reimbursements for employee business expenses.
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Sick pay.
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Vacation pay.
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Benefits under qualified employee benefit programs.
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Meals and lodging.
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The use of a car.
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Flights on airplanes.
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Discounts on property or services.
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Memberships in country clubs or other social clubs.
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Tickets to entertainment or sporting events.
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Accident and health plans.
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Adoption assistance.
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Cafeteria plans.
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Dependent care assistance.
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Educational assistance.
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Group-term life insurance coverage.
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Welfare benefit funds.
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You can generally deduct premiums you pay for the following kinds of insurance related to your business.
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Fire, theft, flood, or similar insurance.
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Credit insurance that covers losses from business bad debts.
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Group hospitalization and medical insurance for employees, including long-term care insurance.
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Liability insurance.
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Malpractice insurance that covers your personal liability for professional negligence resulting in injury or damage to patients or clients.
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Workers' compensation insurance set by state law that covers any claims for bodily injuries or job-related diseases suffered by employees in your business, regardless of fault.
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Contributions to a state unemployment insurance fund are deductible as taxes if they are considered taxes under state law.
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Overhead insurance that pays for business overhead expenses you have during long periods of disability caused by your injury or sickness.
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Car and other vehicle insurance that covers vehicles used in your business for liability, damages, and other losses. If you operate a vehicle partly for personal use, deduct only the part of the insurance premium that applies to the business use of the vehicle. If you use the standard mileage rate to figure your car expenses, you cannot deduct any car insurance premiums.
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Life insurance covering your employees if you are not directly or indirectly the beneficiary under the contract.
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Business interruption insurance that pays for lost profits if your business is shut down due to a fire or other cause.
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Self-insurance reserve funds. You cannot deduct amounts credited to a reserve set up for self-insurance. This applies even if you cannot get business insurance coverage for certain business risks. However, your actual losses may be deductible. For more information, see Publication 547, Casualties, Disasters, and Thefts.
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Loss of earnings. You cannot deduct premiums for a policy that pays for your lost earnings due to sickness or disability. However, see item (8) in the previous list.
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Certain life insurance and annuities.
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For contracts issued before June 9, 1997, you cannot deduct the premiums on a life insurance policy covering you, an employee, or any person with a financial interest in your business if you are directly or indirectly a beneficiary of the policy. You are included among possible beneficiaries of the policy if the policy owner is obligated to repay a loan from you using the proceeds of the policy. A person has a financial interest in your business if the person is an owner or part owner of the business or has lent money to the business.
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For contracts issued after June 8, 1997, you generally cannot deduct the premiums on any life insurance policy, endowment contract, or annuity contract if you are directly or indirectly a beneficiary. The disallowance applies without regard to whom the policy covers.
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Insurance to secure a loan. If you take out a policy on your life or on the life of another person with a financial interest in your business to get or protect a business loan, you cannot deduct the premiums as a business expense. Nor can you deduct the premiums as interest on business loans or as an expense of financing loans. In the event of death, the proceeds of the policy are not taxed as income even if they are used to liquidate the debt.
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You have more than one source of income subject to self-employment tax.
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You file Form 2555 or Form 2555-EZ (relating to foreign earned income).
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You are using amounts paid for qualified long-term care insurance to figure the deduction.
You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your business. Interest relates to your business if you use the proceeds of the loan for a business expense. It does not matter what type of property secures the loan. You can deduct interest on a debt only if you meet all of the following requirements.
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You are legally liable for that debt.
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Both you and the lender intend that the debt be repaid.
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You and the lender have a true debtor-creditor relationship.
You cannot deduct on Schedule C or C-EZ the interest you paid on personal loans. If a loan is part business and part personal, you must divide the interest between the personal part and the business part.
Example.
In 2007, you paid $600 interest on a car loan. During 2007, you used the car 60% for business and 40% for personal purposes. You are claiming actual expenses on the car. You can only deduct $360 (60% × $600) for 2007 on Schedule C or C-EZ. The remaining interest of $240 is a nondeductible personal expense.
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Interest you can deduct.
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Interest you cannot deduct.
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How to allocate interest between personal and business use.
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When to deduct interest.
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The rules for a below-market interest rate loan. (This is generally a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate.)
Legal and professional fees, such as fees charged by accountants, that are ordinary and necessary expenses directly related to operating your business are deductible on Schedule C or C-EZ. However, you usually cannot deduct legal fees you pay to acquire business assets. Add them to the basis of the property.
If the fees include payments for work of a personal nature (such as making a will), you can take a business deduction only for the part of the fee related to your business. The personal part of legal fees for producing or collecting taxable income, doing or keeping your job, or for tax advice may be deductible on Schedule A (Form 1040) if you itemize deductions. For more information, see Publication 529, Miscellaneous Deductions.
You can set up and maintain the following small business retirement plans for yourself and your employees.
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SEP (Simplified Employee Pension) plans.
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SIMPLE (Savings Incentive Match Plan for Employees) plans.
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Qualified plans (including Keogh or H.R. 10 plans).
SEP, SIMPLE, and qualified plans offer you and your employees a tax favored way to save for retirement. You can deduct contributions you make to the plan for your employees on line 19 of Schedule C. If you are a sole proprietor, you can deduct contributions you make to the plan for yourself on line 28 of Form 1040. You can also deduct trustees' fees if contributions to the plan do not cover them. Earnings on the contributions are generally tax free until you or your employees receive distributions from the plan. You may also be able to claim a tax credit of 50% of the first $1,000 of qualified startup costs if you begin a new qualified defined benefit or defined contribution plan (including a 401(k) plan), SIMPLE plan, or simplified employee pension.
Under certain plans, employees can have you contribute limited amounts of their before-tax pay to a plan. These amounts (and earnings on them) are generally tax free until your employees receive distributions from the plan.
For more information on retirement plans for small business, see Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans).
Rent is any amount you pay for the use of property you do not own. In general, you can deduct rent as a business expense only if the rent is for property you use in your business. If you have or will receive equity in or title to the property, you cannot deduct the rent.
You can deduct on Schedule C or C-EZ various federal, state, local, and foreign taxes directly attributable to your business.
Example.
May and Julius Winter drove their car 7,000 business miles out of a total of 10,000 miles. They had to pay $25 for their annual state license tags and $20 for their city registration sticker. They also paid $235 in city personal property tax on the car, for a total of $280. They are claiming their actual car expenses. Because they used the car 70% for business, they can deduct 70% of the $280, or $196, as a business expense.
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Taxes for local benefits, such as those for sidewalks, streets, water mains, and sewer lines.
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Real estate taxes when you buy or sell property during the year.
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Real estate taxes if you use an accrual method of accounting and choose to accrue real estate tax related to a definite period ratably over that period.
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This section briefly explains the kinds of travel and entertainment expenses you can deduct on Schedule C or C-EZ.
Table 8-1. When Are Entertainment Expenses Deductible?
(Note. The following is a summary of the rules for deducting entertainment expenses. For more details about these rules, see Publication 463.)
General rule | You can deduct ordinary and necessary expenses to entertain a client, customer, or employee if the expenses meet the directly-related test or the associated test. |
Definitions |
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Tests to be met | Directly-related test
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Associated test
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Other rules |
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Your duties require you to be away from the general area of your tax home (defined later) substantially longer than an ordinary day's work.
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You need to get sleep or rest to meet the demands of your work while away from home.
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Entertaining guests at nightclubs, athletic clubs, theaters, or sporting events.
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Providing meals, a hotel suite, or a car to business customers or their families.
To deduct expenses related to the part of your home used for business, you must meet specific requirements. Even then, your deduction may be limited.
To qualify to claim expenses for business use of your home, you must meet the following tests.
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Your use of the business part of your home must be:
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Exclusive (however, see Exceptions to exclusive use, later),
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Regular,
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For your business, and
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The business part of your home must be one of the following:
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Your principal place of business (defined later),
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A place where you meet or deal with patients, clients, or customers in the normal course of your business, or
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A separate structure (not attached to your home) you use in connection with your business.
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For the storage of inventory or product samples.
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As a daycare facility.
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You use it exclusively and regularly for administrative or management activities of your business.
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You have no other fixed location where you conduct substantial administrative or management activities of your business.
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The relative importance of the activities performed at each location.
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If the relative importance factor does not determine your principal place of business, you can also consider the time spent at each location.
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The business part of expenses you could deduct even if you did not use your home for business (such as mortgage interest, real estate taxes, and casualty and theft losses that are allowable as itemized deductions on Schedule A (Form 1040)).
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The business expenses that relate to the business activity in the home (for example, business phone, supplies, and depreciation on equipment), but not to the use of the home itself.
You may also be able to deduct the following expenses. See Publication 535 to find out whether you can deduct them.
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Advertising.
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Bank fees.
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Donations to business organizations.
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Education expenses.
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Energy efficient commercial buildings deduction expenses.
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Environmental cleanup costs.
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Impairment-related expenses.
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Interview expense allowances.
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Licenses and regulatory fees.
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Moving machinery.
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Outplacement services.
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Penalties and fines you pay for late performance or nonperformance of a contract.
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Repairs that keep your property in a normal efficient operating condition.
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Repayments of income.
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Subscriptions to trade or professional publications.
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Supplies and materials.
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Utilities.
You usually cannot deduct the following as business expenses. For more information, see Publication 535.
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Bribes and kickbacks.
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Demolition expenses or losses.
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Dues to business, social, athletic, luncheon, sporting, airline, and hotel clubs.
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Penalties and fines you pay to a governmental agency or instrumentality because you broke the law.
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Political contributions.
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Repairs that add to the value of your property or significantly increase its life.
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