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DEDUCTIBLE BUSINESS EXPENSES

 

Understanding the Internal Revenue Code can be a daunting task, but it reveals that many business deductions are not explicitly listed. While the tax law doesn't explicitly mention deductions such as office supplies, the overarching principle is found in the initial sentence of Section 162. This section allows for the deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business."

To elaborate on the basic definitions, an expense is considered ordinary if it aligns with common practices in a specific trade or business. For instance, insurance premiums to safeguard a retail store are deemed an ordinary business expense in the retail industry. On the other hand, a necessary expense is one that is deemed helpful or appropriate, even if not essential for the operation of the business. For instance, a car dealership purchasing an automated external defibrillator may not be necessary for daily operations but can be considered helpful and appropriate in case of a medical emergency.

For an expense to be deductible, it must be both ordinary and necessary. Moreover, the deductible amount must be reasonable concerning the expected benefit. As an example, a $65 lunch with a potential client may be considered reasonable in pursuit of a $3,000 deal. It's crucial to note that the Tax Cuts and Jobs Act has altered the landscape, eliminating many deductions for entertainment expenses while retaining the 50% deduction for business meals.

Despite these general guidelines, disagreements between taxpayers and the IRS are not uncommon when determining what qualifies as ordinary and necessary expenditures. Examining three cases from 2023 highlights such issues:

  1. A married couple owning an engineering firm faced disallowed deductions and assessed taxes and penalties for claiming unsupported vehicle depreciation and mileage deductions.
  2. A married couple was denied business tax deductions as the husband's consulting company failed to prove engagement in a trade or business, and expenses weren't properly substantiated.
  3. A gene therapy specialist faced challenges in deducting legal expenses, with the Tax Court allowing only a portion for business-related legal issues.

In navigating these complexities, caution is advised. While some expenses are straightforwardly deductible, others can be more intricate. If an expense appears unusual for your industry or could be perceived as personal or extravagant, it's prudent to proceed with caution. Maintaining meticulous records to substantiate deductions is essential, and seeking professional guidance is recommended for clarity in complex cases.

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