Everybody asks About Deducting Business Expenses
Spoiler Alert: there is homework attached to this post. Read through to the end.
One of the issues I will be dealing with in my tax preparation workshops (info at www.indytaxschool.com) is determining what expenses are deductible. I’m going to get a little tax geeky here for a minute to try to explain the whole issue of why expenses are deductible.
It is based on what’s called the Doctrine of Economic Substance. This doctrine holds that a transaction must have a purpose other than the reduction of tax liability. In general, that means that the purpose of buying inventory for a retail store is to sell the inventory and create a profit. Since the profit is what is taxed, the purchase of inventory has economic substance.
The 16th Amendment to the Constitution grants Congress the power to “…lay and collect taxes on incomes, from whatever source derived….” Income for a business is the same as profit. So business costs are deducted from the company’s receipts to determine the gross profit, or taxable income.
Business activity generates wealth whether from manufacturing, resale, repair, personal service or any activity that money is received for. The income of an employee, however, is not considered business activity. Therefore, the expenses that are deductible for individuals are personal in nature. Only certain kinds of expenses are allowed to be deducted, for purposes known best to Congress.
Business purpose is the handmaiden of Economic Substance. The activity must have a business purpose, that is, it must have the purpose of making money.
You can’t deduct something without there being a connection to the business operation. This is the reason that dog food for Fido, your loyal lap dog, is not deductible, but the dog food for Killer, the guard dog at your auto salvage yard, is. It places practical limits on what you can deduct in your business as a business expense. But it also can justify expenses you might otherwise consider personal.
OK, I’ll stop the explanation now and just tell you what this means for your business.
Anything that directly relates to the operation of your business is deductible. There may be some things that must be prorated or otherwise reduced, but the business portion of those expenses remains deductible.
Some examples are obvious, some not:
- Office supplies
- Regular maintenance
- Trash removal
- Window washing
- Professional development
- AV equipment
- Mobile equipment
- Employee expenses
- Meals for employees
- Stockholder meetings
- Lodging for employees
- Transportation for employees
- Medical expenses
- Employee benefits
- Fees and licenses of all kinds
- Continuing education
- Employee education
- Board meetings
- Charitable deductions for business purpose
- Professional fees
- Accounting costs
- Consulting costs
- Conventions and trade shows
- Internet hosting
- Web services
- Gifts to customers
- Customer discounts
- Payroll taxes for employees
- Newspapers and magazines
- Cable TV
- and on and on
You see, there is no master list built into the tax code. The business owner has the responsibility to find any and all valid deductions which fall under the twin concepts of business purpose and economic substance.
Your homework is to add some comments to this entry with ideas you have for your business for valid deductions.
I’ll be interested to see what you come up with.