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There’s a lot of misinformation in books and on the internet about taking tax deductions for business expenses.
Ordinary and Necessary
For example, there are some books that claim that once you incorporate a business, you can deduct virtually any expense. Phone bill? No problem. New desk? No problem. A cherry-red Porsche? Hey, you need it to impress clients, right? Deduct it.
Wrong. The IRS only allows deductions for “ordinary and necessary expenses”. See Internal Revenue Code 162. ‘Trade or business expenses.’
If the what you’re trying to deduct isn’t “ordinary” for your line of business, then there’s no deduction. If the expense isn’t “necessary” for your line of business, then again, no deduction.
Who decides the definition of “ordinary” and “reasonable”? That elusive and everpresent figure in the common law–the reasonable person. Would a reasonable person consider a new mink coat to be an ordinary and reasonable expense of operating a plumbing business out of their home?
In other words, does your deduction pass the laugh test? If think you’re pulling something over the service’s eyes, then you have probably failed the laugh test.
Ultimately, if it goes that far, a federal judge will decide if your claimed expense is ordinary or necessary.
Entities and Deductions
Others claim that you cannot deduct a business expense until you’ve incorporated your business either as a corporation, S corporation, LLC, or partnership. Again, wrong.
Any business, even unincorporated ones, can take deductions for ordinary and necessary business expenses. You report these expenses, along with revenues, on your 1040 Schedule C.
Now, there are some tax disadvantages to this. For one, taxpayers using their Schedule C get audited at about 10 times the rate that partnerships and LLCs do. Secondly, there are ways to minimize your self-employment tax by using incorporating, as well.
No one page article can delve into the minute details of the tax code. If you’re serious about your business and maximizing your take home income, you need to invest in some good tax advice.
It’s 10:30pm, Do You Know Where Your Tax Deductions Are?
The first step is knowing which deductions you can take.
The second step is a system for keeping track of all your expenses.
A shoebox, a “junk drawer”, or “it’s all in my head” are not acceptable systems.
QuickBooks is the leader in small business accounting software for a reason: it works.