Contributed by: Henry, FreeTaxUSA Agent, Tax Pro
One common question that arises for business owners is whether all business expenses must be claimed. Understanding the legal requirements when it comes to claiming expenses can help you make informed decisions and avoid potential pitfalls.
Claiming business expenses
According to the IRS, self-employed individuals are legally required to report all income and deduct all expenses. This rule applies when determining your net earnings for self-employment tax and earned income tax credit (EITC) purposes.
You may hesitate to claim all your business expenses because it decreases the amount of your EITC, but reporting only what is most beneficial is not allowed. You must deduct all allowable expenses.
Deductible expenses
Understanding what are considered deductible expenses can help ensure you follow the IRS rules. For a business expense to be deductible, it needs to be both ordinary and necessary. An expense is considered ordinary if it’s common and accepted in your industry. It is considered necessary if it’s helpful and appropriate for your business.
Common deductible business expenses include:
- Labor expenses such as wages and contract labor costs, commissions and fees, employee benefit programs, and pension/profit-sharing plans
- Administrative expenses such as repairs and maintenance, business travel, insurance, taxes and licenses, and legal/professional services
- Operations expenses such as supplies, advertising, office expenses, utilities, equipment rent, mortgage interest, and depletion
- Properly substantiated vehicle expenses (a mileage log of all business miles is required)
- Properly substantiated business meals (receipts and records of the business reason for all meals are required)
- Home office expenses (the home office area must be used exclusively and regularly for business)
- Depreciable assets
Some business costs are never deductible, such as charitable contributions, entertainment expenses, political contributions, and penalties and fines you pay to the government because you broke the law.
Refer to chapter 8 of IRS Publication 334 for a thorough explanation of business expenses you can and cannot deduct.
Filing an accurate tax return
You need to file Schedule C with your tax return and fill out Part II to list your business costs.
Be sure to keep records that support your expenses in case your return is selected for examination or if you receive an IRS notice. The IRS may apply an accuracy-related penalty and charge interest if you don’t file an accurate tax return.
