Highlights to Section 162: Tax-Deductible Business Expenses

by Catalin Clarke, CPA

“Ordinary and Necessary”

Under Section 162 of The Internal Revenue Code we can find three words that summarize what makes a business expense tax-deductible; “ordinary and necessary.” This line serves as a rough guide, but not necessarily a definitive rule. Below are some highlights, examples, and potential pratfalls a self-employed taxpayer should be aware of. This is not an exhaustive list, rather a guide. One item particularly of note is that expenses paid via credit card are deductible when the credit card purchase is made, not when the credit card bill is paid.

Advertising

Any ordinary or necessary expense related to promoting your business are allowed such as website banner ads or other promotional materials. Any expense related to influencing legislation is not deductible.

Dues and Subscriptions

Dues to business (not social) clubs are deductible as a business expense. This also includes subscriptions to trade publications.

Vehicle Expenses

Taxpayers can keep a log of motor vehicle expenses and then allocate them to the business based on the ratio of business miles to total. Eligible expenses include but are not limited to maintenance, fuel, insurance, etc.  For example, a car driven a total of 8,000 total miles in a tax year with 2,000 for business purposes would be 25% business use. If the vehicle expenses were $1,000 for the year, the deduction would be $250. Taxpayers may also use a more simplified method of taking the federal mileage rate ($0.58 for 2019). Under this method the deduction would be $1,160 (2,000 business miles X $0.58 per mile).

Labor Costs

This includes expenses paid for wages, contract labor, and employee benefits. Any deduction is reduced by the amount of employment related tax credits received by the taxpayer.

After Tax Health Insurance Premiums

Health insurance premiums paid by a self-employed person are deductible as a business expense and not subject to the limits an employee would face on their Schedule A. Pre-tax health insurance premiums are not eligible for this deduction.

Accountant, Legal, and Other Professional Fees

This relates to professional fees paid for the ongoing operation of a business. Fees paid for tax filings, legal counsel, or other professional services such as business coaching are deductible.

Home Office Expenses

If a portion of a taxpayer’s home is used exclusively for business purposes a portion of the mortgage interest, utilities, property taxes, HOA fees, and other home related expenses may be deducted from taxable income. If the taxpayer owns their home a deduction for depreciation may be taken. For example, a taxpayer with a 160 square foot home office in a 1,600 square foot home could deduct 10% of the aforementioned costs as business expenses. Special rules apply for in-home daycare facilities.

Interest

Interest paid for business purchases is deductible as a business expense, such as interest paid on an operating line of credit. Bank and credit card fees are also deductible. Other restrictions come into play when a business’s gross receipts exceed $25 Million.

State and Local Taxes

Taxes, licenses, fees paid to a state or local taxing authority are deductible from federal income. LLC renewal fees, employer paid payroll taxes, B&O taxes are examples. Note of caution: any fine or penalty assessed such as a parking is not deductible. Legal fees related to any to fines & penalties are also not deductible.

Clothing and Attire

Uniforms, protective equipment, and such are tax deductible. Clothing purchased is generally not deductible if it can be worn elsewhere. For example, an exterminator’s jumpsuit is a deductible whereas a suit purchased for business meetings is not.

Meals and Entertainment

Entertainment expenses, sometimes including food costs related to entertainment events, are no longer deductible. However, if purchased separately from the event, food and drinks that are provided during entertainment events will not be considered entertainment expenses. A meal such as a dinner with a potential client is still 50% tax-deductible.

Gifts

Business gifts are limited to a maximum deduction of $25 per recipient per year. As long as they cost less than $4 individually, identical branded marketing items like pens and paperweights are considered promotional materials and not gifts. Items that could be considered either gifts or entertainment, such as sports tickets, are generally considered entertainment expenses and therefore non-deductible.