What’s a business expense?
New Business Owners
For many taking their first step into the world of entrepreneurship, a big question is “what can I write off?” The answer to this question, as is the answer to most tax questions, is “it depends.”
The Internal Revenue Code is delightfully vague when it comes to defining a business expense. The actual language is: “There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business…” The section goes on to point out a few things that are specifically included (such as salaries and traveling expenses) and a few things that are specifically excluded (including illegal bribes and certain lobbying expenses), but by and large, the phrase “ordinary and necessary” has a broad range of interpretation and is generally based on what type of business you are running and what others in similar business are doing.
Are you running a business?
Before you can take an expense as a tax deduction, you first need to have a trade or business. In general, if you have a profit motive and are seeking to earn money through some sort of work (we’re not talking about investing in the stock market or earning interest on loans, though this could be a trade or business if you’re in the financial industry), then you’ve got a trade or business. A profit motive is different than actually making a profit. You don’t actually have to turn a profit in order to be running a trade or business. If you go too many years without getting out of the red, the IRS will likely want to have a discussion about whether you have a bona fide business versus a hobby, but this isn’t something you’d have to worry about in the first couple years of operations. Don’t forget, losses are great for reducing the taxes you pay. Side bar: non-profit organizations generally get to enjoy the same deductions despite the fact they don’t have a profit motive.
Ok, but we still haven’t told you what you can deduct
The easiest way to illustrate what you can deduct is to tell you what you can’t deduct. Let’s do this by comparing two businesses. One is a coffee shop, the other is a construction company. For both, the cost of office supplies, like pens, pencils, paper, printers, and computers would all qualify as a business deduction as long as these things are being used in the business. The owner can’t buy a laptop for her son to use in college and call that a business expense.
On the other hand, while both businesses need equipment to operate, the equipment is different. Clearly the coffee shop doesn’t need a skid steer in order to roast beans, brew coffee, steam milk, or wash dishes. It’s not ordinary that coffee shops have skid steers nor is it necessary to have one. Similarly, while a construction company will likely have a coffee machine in its office, a commercial coffee bean roaster is not something you would ordinarily see at a construction site, nor is it a piece of equipment that is necessary to build a house.
Speaking of equipment…
While a piece of equipment (or other asset used in your business) may meet the ordinary and necessary test, keep in mind you may have to depreciate at it, that is expense a portion of it, over several years. Many business assets qualify for accelerated depreciation which allows you to expense all or most of the expense in the year you start using it, but some, such as smaller automobiles and real property, have limits on how much expense you can recognize each year.
If you’re unsure as to whether something will qualify as a business expense, contact your Amatics accountant. You should be able to talk about how the expense will help your business generate revenue, and of course be prepared for the possibility that the answer might be “no.”