When starting a new small business, one of the most common questions is simply this: “What’s deductible?” It’s a great question and this article will attempt to answer it.
An expense is deductible provided it is ordinary and necessary. Ordinary means that it is an accepted expense in your particular trade or business; it is common. Obvious examples would include office rent for an attorney or fuel for a truck driver. You don’t have to think too hard to understand the idea of an “ordinary” expense.
Necessary means that the expense is helpful and appropriate for your business situation. In other words, it is needed in order for you to produce revenue. Again, there are plenty of self-evident examples. If you are a traveling salesman and you cover a four state territory, it will be necessary for you to travel throughout your territory to solicit new business and provide services to existing customers. So your travel expenses incurred in the process of doing business would be “necessary” and therefore deductible.
The “ordinary and necessary” rule provides the general guideline for determining the deductibility of an expense. To get a more specific list, a good place to turn would be the IRS small business income tax forms. Sole proprietors use Schedule C, which is filed as part of their personal income tax return (Form 1040). Partnerships use Form 1065. C corporations file Form 1120 and S corporations file Form 1120S. Limited liability companies are like a chameleon and can be taxed like any of the other four entities just mentioned; so you must know how the LLC is being treated for tax purposes in order to know which tax form to use.
Each of these tax forms provides a list of potential business expenses that may be deductible in your business, assuming you actually incurred those particular expenses. If you are looking for a basic list of deductible business expense categories, these business tax return forms are the logical place to start.
Another great resource for deductions is the IRS website at http://www.irs.gov. Here you’ll find a plethora of excellent resources for the small business owner or self-employed person. The IRS has produced a series of free publications for each of the business entities mentioned above, and each of these publications contain detailed information on a number of deductible business expenses.
For example, if you are a sole proprietor, check out Publication 334, Tax Guide for Small Business. This is written specifically for self-employed individuals who file Schedule C for their small business. C corporations, S Corporations and partnerships have similar publications. If you’re looking for free information on what’s deductible, these resources will get you started.