If you study the Internal Revenue Code—which you most likely won’t want to—you might be surprised to learn that the majority of company deductions aren’t mentioned in detail. For instance, it isn’t specifically stated in the tax code that you can write off office supplies and other costs. Some expenses are mentioned in the tax code, but the general guideline is found in the first sentence of Section 162, which specifies that you can write off “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”
What are Ordinary and Necessary Expenses?
Generally speaking, an expense is deemed ordinary if it is accepted as typical or regular in a specific industry or business. For instance, in the retail sector, paying insurance premiums to safeguard a store would be considered a standard business expense.
An expense is considered necessary if it is beneficial or appropriate. Let’s take the scenario where an automated external defibrillator is purchased by a car dealership. While it might not be essential to the running of the business, it might be appropriate and beneficial in the event that a client or employee has a cardiac arrest.
Although an item must be both ordinary and necessary in order to be deducted, it is possible for an ordinary expense to be unnecessary.
Furthermore, a deductible amount needs to make sense given the anticipated benefit. For instance, the IRS should approve of a $65 lunch with a prospective client if you’re trying to close a $3,000 contract. (Remember that the Tax Cuts and Jobs Act kept the 50% deduction for business meals but eliminated most other deductions for entertainment costs.)
What Expenses Can’t be Written Off?
It should come as no surprise that taxpayers are not always in agreement with the IRS and courts regarding what constitutes an ordinary and necessary expenditure. Here are three examples from 2023 to highlight a few of the expenses that can’t be written off:
1. An engineering firm was owned by a married couple. They claimed depreciation of $76,264 on three automobiles for two tax years, but they failed to include the necessary information on the ownership, cost, and useful life of each vehicle. Despite providing receipts and mileage logs and claiming $34,197 in mileage deductions, the U.S. Tax Court determined that they failed to demonstrate any relevant business purposes. The reported mileage also included commuting expenses, which the court said cannot be deducted. The court imposed fines and taxes in addition to disallowing these deductions. (TC Memo 2023-39)
2. The Tax Court ruled that a married couple wasn’t entitled to business tax deductions because the husband’s consulting company failed to show that it was engaged in a trade or business. In fact, the consulting firm’s bills were generated before it was incorporated. Furthermore, the court decided that the expenses were improperly substantiated, even if they were reasonable. (TC Memo 2023-80)
3. A gene therapy doctor claimed $360,295 in legal expenditures over a two-year period on joint Schedule C business tax forms. According to the Tax Court, the majority of the legal costs were incurred to protect the spouse from accusations of improper personal behavior. The court permitted a $13,000 deduction for business-related legal expenses but disallowed the deduction for personal legal expenses. (TC Memo 2023-42)
Continue with caution
The deductibility of some expenses is clear. But for other expenses, it can get more complicated. In general, you should proceed cautiously if an expense is out of the ordinary for your industry or if it might be viewed as frivolous, personal, or expensive. Additionally, maintain thorough documentation to support the costs you are deducting. If you have questions about what you can or canont write off, contact us.