Deducting Business Expenses: Separating Fact From Myth

When you're filing your tax returns, what expenses can you deduct from business income?

It's a complex question. To start with, a business expense must be both ordinary and necessary to be deductible, according to the IRS. An ordinary expense is one that's common and accepted in your trade or business. A necessary expense is one that's helpful and appropriate for your trade or business; it doesn't always mean an indispensable cost. Since only business expenses are deductible, they must be separated from other types of expenses: those that are included in the cost of goods sold, capital expenses and personal expenses.

The cost of goods sold is figured by valuing inventory at the beginning and end of each tax year. The total value is deducted from your gross receipts to figure your gross profit for the year. If you include an expense in the cost of goods sold, you cannot deduct it again as a business expense.

Such expenses as the cost of products or raw materials, freight, storage, and direct labor costs including contributions to pensions or annuities for workers who produce the products and factory overhead all go into figuring the cost of goods sold.

You must capitalize some costs rather than deduct them. These costs, part of your investment in your business, are called capital expenses and are considered assets in your business. Generally, there are three types of costs that you should capitalize:

Note that you can decide to deduct or amortize some business startup costs.

You cannot deduct personal, living or family expenses. But if you have an expense for something used partly for business and partly for personal purposes, divide the total cost between the business and personal parts and then deduct the business part.

What if you use part of your home for business? You may be able to deduct expenses for the business use of your home. These may include mortgage interest, insurance, utilities, repairs and depreciation. If you use your car for your business, you can deduct car expenses. If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage.

Other common business expenses include:

This is just an introduction to a technical topic. Be sure to work closely with one of our qualified tax professionals at MHCS CPAs to understand business expenses more fully.

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