Understanding Non-Deductible Business Expenses: What You Need to Know

When navigating the complexities of the Internal Revenue Code, business owners often discover that many deductions aren’t explicitly listed. The key guideline for business deductions is found in Section 162, which permits the deduction of “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” This section outlines the general principle, but the specifics can be nuanced.

Basic Definitions

To understand what expenses are deductible, it’s helpful to grasp a couple of basic definitions:

• Ordinary Expense: This refers to an expense that is common and accepted in your trade or business. For instance, insurance premiums to protect a retail store are considered ordinary in the retail sector.
• Necessary Expense: An expense is deemed necessary if it is helpful and appropriate for your business. For example, a car dealership might purchase an automatic defibrillator. While it’s not essential for day-to-day operations, it’s beneficial for safety. It’s crucial that an expense be both ordinary and necessary to qualify for a deduction.

Additionally, the expense must be reasonable in relation to the benefit it is expected to bring. For instance, spending $65 on a lunch to secure a $3,000 deal is generally acceptable under IRS guidelines, especially since the Tax Cuts and Jobs Act retains a 50% deduction for business meals, although most entertainment expenses are no longer deductible.

Proceed with Caution

While some deductions are straightforward, others can be complex. It is vital to keep meticulous records to substantiate any expense you plan to deduct. If an expense appears unusual in your industry or seems personal or extravagant, tread carefully. The IRS and courts often scrutinize what is deemed ordinary and necessary, leading to disagreements with taxpayers. Here are a few relevant cases to illustrate this point:

Relevant U.S. Tax Court Cases

1. Engineering Firm Vehicle Deductions (TC Memo 2023-39): A married couple claimed $76,264 in vehicle depreciation and $34,197 in mileage deductions over two years on three vehicles. However, they failed to provide essential details like vehicle ownership, cost, and useful life. Additionally, the court found that some mileage deductions included commuting costs, which are non-deductible. The court disallowed these deductions, leading to taxes and penalties.
2. Consulting Firm Deductions (TC Memo 2023-80): A husband’s consulting company failed to demonstrate it was engaged in a trade or business, with invoices predating the company’s incorporation. Even if some expenses were legitimate, they weren’t adequately substantiated, resulting in the disallowance of these deductions.
3. Physician’s Legal Expenses (TC Memo 2023-42): A physician claimed $360,295 in legal expenses over two years on Schedule C of his joint tax returns, but most were related to personal conduct issues. The court allowed only $13,000 for business-related legal expenses, denying the deduction for personal legal costs.

Understanding what expenses can’t be written off by your business is essential for compliance and financial accuracy. Always keep detailed records and consult with tax professionals to ensure your deductions align with IRS guidelines. If you have any questions about what expenses are deductible, don’t hesitate to reach out to us for expert advice.

The HoganTaylor Tax Practice

If you have any questions about the content of this publication, or if you would like more information about HoganTaylor's Tax practice, please email Tony Otto, Tax Practice Lead, at jotto@hogantaylor.com.

INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.