Non-Deductible Business Expenses

If you own a small business or are self-employed, you've probably heard you can "write off" certain business expenses on your federal income tax return. In most cases, when someone refers to a tax write-off, they mean legitimate business expenses paid from your own pocket. If you're a business owner, these expenses are generally reported on Schedule C (Form 1040). They're deducted from any income you earned from your business. This reduces the amount of your business income subject to tax from the costs of operating your business.

However, not all expenses are deductible. The Internal Revenue Service isn't kind to taxpayers who get creative on their returns and claim business deductions for their personal spending. For example, you can't take the family to Disney World for the week and then claim a tax deduction for the entire cost as a business trip because you had one client meeting in Orlando. You must be able to prove that the claimed expenses were business-related.

Small business owners and sole proprietors must understand precisely what expenses can be used to reduce their tax liability. You should also know the portion that's deductible—you can end up paying back taxes, penalties, and interest if the IRS rejects your claimed expenses.

Who Can Deduct Business Expenses?

There was a time when most employees could claim a deduction for their out-of-pocket business expenses, known as unreimbursed employee expenses. But the Tax Cuts and Jobs Act (TCJA) in 2017 eliminated the deduction for most unreimbursed employee expenses. As a result, business deductions can only be claimed on your individual income tax return when you own your own business.

It doesn't matter whether you're operating your business as your primary job or simply pursuing a side hustle to earn a little extra cash—the expenses you incur while conducting a business activity can be claimed as Schedule C deductions. Schedule C is also where you'll report the income and losses from your business to arrive at its taxable income. Schedule C is used to claim business deductions regardless of whether you claim itemized deductions or the standard deduction.

What Expenses Can't be Deducted?

The general rule of thumb is that deductible business expenses for tax purposes are the ordinary and necessary expenses incurred in operating your business. When it comes to determining whether a business expense is "ordinary," the IRS will consider common expenses in your industry. Expenses that are necessary are those that are helpful and appropriate for your business.

The IRS will almost never find several specific categories of expenses ordinary and necessary for a business. These non-allowable expenses include:

• Personal expenses: In most cases, when the IRS finds an expense unrelated to your business, it's classified as a personal or family expense.

• Entertainment expenses: The TCJA eliminated the general deduction for entertainment expenses. Business meals aren't included in entertainment expenses and may be partially deductible (discussed below).

• Club membership: While some small business owners join country clubs and athletic clubs to entertain clients or make business connections, membership dues are not deductible.

• Child care: The expenses related to child care needed to conduct your business are not deductible. But you may be eligible to claim the child and dependent care tax credit for those expenses.

• Commuting expenses: Expenses related to a taxpayer getting to and from their regular place of employment are not deductible as travel expenses.

• Non-business legal fees: Legal fees for such things as setting up a family trust, purchasing a home, and divorce are not deductible.

• Charitable contributions: Unless your small business is incorporated as a C corporation, charitable contributions are not deductible as business expenses. However, if you itemize your deductions, you can claim them as a deduction on your individual income tax return.

• Political contributions: Contributions to political candidates or organizations are generally non-deductible and rarely qualify as a business expense. The exceptions to this rule are usually for donations to non-partisan activities, such as sponsoring a local debate open to candidates from all political parties.

• Life insurance premiums: Premiums paid for life insurance are generally not deductible unless your business also pays the premiums for its employees.

Business Meals

In most situations, business meal expenses that don't qualify as non-deductible entertainment are 50% deductible. So, if you spend $100 taking a client out to lunch, you can only claim a $50 deduction. Workplace snacks available to employees and customers are also 50% deductible.

The cost of food and drinks provided for a company-wide party or event is 100% deductible if it has a clear business purpose. Business purposes can include employee recognition and celebrating company achievements. If you plan on claiming a deduction for a company-wide party, keep records related to its business purpose should the IRS conduct an audit.

Home Offices

While the expenses related to a home office are generally deductible, the area claimed as a home office must be used regularly and exclusively for business purposes. If you run your business from your kitchen table, you can't claim it as a home office if you also use it to prepare and serve meals for your family.

Still Have Questions? A Tax Lawyer Can Help

If you own a small business and have questions about which business expenses are deductible, a local tax attorney can help. Tax lawyers are tax professionals who understand the IRS's rules for business deductions. They can help you determine which expenses are and aren't deductible. A tax attorney can also represent you if the IRS has questions regarding business deductions you may have claimed on previous returns.