Business expenses are the cost of conducting a trade or business. These expenses are usually deductible if the business operates to gain a profit.
What Can I Deduct?
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is helpful and appropriate for your trade or business.
It is essential to separate business expenses from the following ones:
The expenses used to calculate the cost of goods sold (COGS)
Capital Expenses
Personal Expenses
Cost of Goods Sold
If your business manufactures products or purchases them for resale, you generally must value inventory at the beginning and end of each tax year to determine COGS. Some of expenses may be included in figuring the COGS. The COGS is deducted from your gross receipts to figure gross profit for the year. If you encompass an expense in the COGS, you cannot deduct it again as a business expense.
To illustrate, several samples of expenses go into figuring the COGS.
The cost of products or raw materials, including freight
Storage
Direct labor costs (including contributions to pensions or annuity plans) for workers producing the products
Factory overhead
Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs. This rule does not apply to personal property acquired for resale if your average annual gross receipts (or those of your predecessor) for the preceding 3 tax years are not more than $10 million.
For more details, refer to the chapter on COGS, Publication 334, Tax Guide for Small Businesses and the chapter on Inventories, Publication 538, Accounting Periods and Methods.
Capital Expenses
Capital expenses is considered assets in your business. In general, there are three forms of costs you capitalize.
Business start-up costs (See the note below)
Business assets
Improvements
Note: You can elect to deduct or amortize certain business start-up costs. Refer to chapters 7 and 8 of Publication 535, Business Expenses.
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Personal versus Business Expenses
If possible, divide the total cost between the business and personal parts. You can deduct the business part.
For example, if you borrow money and use 75% of it for business and the other 25% for a family vacation, you can deduct 75% of the interest as a business expense. The remaining 25% is personal interest and is not deductible. Refer to chapter 4 of Publication 535, Business Expenses, for information on deducting interest and the allocation rules.
Business Use of Your Home
You may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Refer to Home Office Deduction and Publication 587, Business Use of Your Home, for more breakdown.
Business Use of Your Car
If you use your car in your business, you can deduct car expenses. If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. Refer to Publication 463, Travel, Entertainment, Gift, and Car Expenses. For a list of current and prior year mileage rates see the Standard Mileage Rates.
Other Types of Business Expenses
Employees' Pay - You can usually deduct the pay you give your employees for the services performed for your business.
Retirement Plans - Retirement plans are savings plans offering you tax advantages to set aside money for your own, and your employees' retirement.
Rent Expense - In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. If you have or will receive equity in or title to the property, the rent is not deductible.
Interest - Business interest expense is an amount charged for the use of money you borrowed for business activities.
Taxes - You can deduct various federal, state, local, and foreign taxes directly attributable to your trade or business as business expenses.
Insurance - Generally, you can deduct the ordinary and necessary cost of insurance as a business expense, if it is for your trade, business, or profession.
This list is not all inclusive of the types of business expenses that you can deduct. For additional info, refer to Publication 535, Business Expenses.
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