What are Ordinary and Necessary Business expenses?

In order for a business expense to be deductible on a tax return, it most be considered an ordinary and necessary business expense under IRS standards. The broadest definition given by the IRS is that a business expense must be both ordinary and necessary.

What are Ordinary and Necessary Business expenses?

For most taxpayers, this means that for ordinary expense, it must be an is one that is common and generally accepted accepted in your trade or business and other businesses also would probably deduct it. By contrast, a necessary business expense is one that is helpful and appropriate for a taxpayer’s trade or business. This is a broader standard and does not mean that the expense is absolutely required or necessary for a business.

 

Tax Deductions for Ordinary and Necessary Expenses

The IRS code section § 162 explicitly says that deductions shall be allowable for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Below are some more definitions for determining what is a necessary and ordinary business expense.

Necessary means and is defined as “appropriate and helpful” in the development of the taxpayer’s business or trade. It is not that strict because a requirement that a business show the absolute necessity expenses would put the IRS in the position of reviewing every business decision to ensure that no money was spent unnecessarily. This would be tedious and impede the enforcement of tax laws.

Ordinary Expense-  Determining what is considered ordinary is more controversial when determining what is a business deduction.  “Ordinary Business Expense” means something that is “normal, usual, or customary” in the taxpayer’s business and will be actually incurred by the taxpayer.

 

It is important to separate business expenses from the following expenses:

  • The expenses used to figure the cost of goods sold,
  • Capital Expenses, and
  • Personal Expenses.

 

Other Types of Deductible Business Expenses

  • Employees’ Pay – You can deduct the salary or pay of an employee in a business
  • Retirement Plans – There are special laws regarding contributions to employee retirement plans
  • Rent Expense – You can deduct rent for a building that is used in a trade or business
  • Interest – You can deduct interest on money borrowed
  • Taxes – You can deduct various federal, state, local, and foreign taxes incurred by your business.
  • Insurance –  You can deduct any insurance costs related to your business

 

You cannot deduct personal, living, or family expenses

Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part. Therefore, it is very important to determine what is considered a deductible business expense in order to avoid any problems with the IRS.