What are non-deductible business expenses?

According to the IRS, a deductible business expense must be ordinary and necessary. Therefore, any expense that is not ordinary and necessary for the operation of your business is not deductible. In addition to this broad definition, the IRS provides guidance on specific business expenses that cannot be deducted. This article provides more information about each of these nondeductible business expenses, along with examples.

entertainment business

The Tax Cuts and Jobs Act of 2017 eliminated the deduction for entertainment expenses, which means you can’t deduct the cost of entertaining patrons at sporting events, concerts, or private clubs. It doesn’t matter if you entertain and discuss business with a customer or employee, entertainment-related expenses are not deductible. However, business meals at entertainment events are deductible if you have an itemized receipt showing the cost of the meals separate from the entertainment event.

Let’s say you invite your favorite customer to a baseball game. You buy tickets for both in advance and treat your customer to hot dogs and drinks while he’s at the game. Since the game of baseball is considered entertainment, it is not deductible. The cost of the hot dogs and beverages, which are purchased separately from the tickets, is not an entertainment expense and is not subject to disallowance. Therefore, you can deduct 50% of the expenses associated with hot dogs and beverages purchased in-game as a meal expense.

50% of business meals

Typically, you can deduct only 50% of food and beverage costs, with the caveat that they cannot be “lavish or extravagant” and the business owner or employee must be present. In 2021, the Consolidated Appropriations Law allowed a full 100% deduction for business meals in 2021 and 2022, as long as they are provided by a restaurant.

Here are some of the more common 50% deductible expenses that are 100% deductible if purchased at a restaurant before the end of 2022:

  • A meal with a client where work is discussed (not fancy)
  • Employee meals while traveling
  • Meals for employees at a conference, on top of the ticket price
  • Food for a board meeting
  • Dinner provided for employees who work late

Taxes

Taxes that cannot be deducted as business expenses include:

  • federal income taxes
  • 50% of self-employment taxes are non-deductible and 50% are deductible as an adjustment to income for the sole proprietor or partner
  • Taxes on successions, inheritances, legacies, successions and donations
  • Real estate taxes prorated at closing

Employers can deduct employment taxes, such as social security and unemployment tax, that they must pay on their employees’ wages.

Sanctions and Fines

The fines and penalties that a company pays to the government for the violation of any law are never deductible. For example, you can’t deduct an underpayment penalty, a late payment penalty, or a late filing penalty. However, interest paid to the IRS is deductible if the underlying income tax liability is business-related.

Non-deductible penalties and fines are not limited to tax-related items. Any fine or sanction is not deductible. For example, no matter how much you argue that speeding is normal and necessary for your business, the penalty for your speeding ticket is not deductible.

Political Contributions

Gifts and contributions made to political parties are generally not deductible, as are expenses incurred to participate in any political campaign of a candidate for public office. The rule also applies to indirect contributions, such as advertising in a program for a political party’s convention or tickets to an inaugural ball that is identified with a political party. In both cases, if the income from the program or event is for the use of the party or candidate, the associated expenses are not deductible.

Illegal payments

Payments made to officials or employees of a foreign government are not deductible if the payments are illegal under the Foreign Corrupt Practices Act of 1977. Also. payments made to officials or employees of any government other than a foreign government are not deductible if the payments constitute a bribe or kickback.

A kickback is a payment for referring a customer, patient, or client. It commonly occurs when someone is given money to influence a third party to buy, use services or otherwise deal with the person paying the bribe.

Interestingly, the ordinary and necessary business expenses of an illegal business are deductible from the income of the illegal business. An example would be the security expense of an illegal gambling den or bribery of government officials.

It sounds strange to think that a tax return is filed for an illegal business and ordinary and necessary expenses are deducted. These returns are usually filed after the suspect is arrested and the IRS learns of the untaxed income.

Business Expenses of Drug Trafficking

Unlike most illegal activities, the ordinary and necessary expenses of drug trafficking are not deductible. You cannot, for example, deduct money you paid for smuggling illegal substances into the country, money laundering, or other illegal activities such as bribes and kickbacks.

When someone in drug trafficking is arrested, the IRS can include all estimated income they earned in taxable income without allowing any deductions against that income. This is much harsher than for other illegal activities where business deductions are allowed.

Purchases of Property, Plant and Equipment

One of the principles behind the tax rules for deductions is that your income for the year should only be offset against those expenses that contributed to that income. Capital expenses to acquire or improve a business asset that will last more than one year are not deductible as business expenses.

The IRS considers capital expenditures for the purchase of long-term business assets, such as vehicles, equipment, and buildings, as investments in your business, not expenses. In this case, you may be able to deduct the full purchase price under Bonus Depreciation or Section 179.

The IRS has adopted new rules designed to help classify whether an item is a “repair,” which is generally deductible in the year it’s made, or an “improvement” that must be added to the basis of property and deducted over a period of time. period of years. Because these rules are complex and could have huge tax ramifications, it’s a good idea to consult with an accountant before making any substantial repairs or improvements to your property.

The following items have been deemed capital expenditures by the IRS:

  • Burglar alarm installation costs
  • Flood Protection Costs
  • Business facility improvement costs, such as replacing a roof
  • insulation costs
  • Showcases, remodeling costs
  • Cable replacement costs in case of sudden failure
  • Office, cost of change of location and equipment
  • Electrical System Replacement Costs

Determining whether a payment is a deductible expense versus a capital expense can be difficult. Bench provides unlimited tax advice in its Premium accounting plan.

What is an ordinary and necessary business expense?

Unless an expense falls under one of the nondeductible expenses listed above, it can be deducted if it is ordinary and necessary. Courts generally interpret ordinary to mean an expense that is common within a specific trade or business, while necessary to mean useful and appropriate. If you have a delivery business, the ordinary and necessary expenses would be the fuel, maintenance, and tolls associated with your vehicles.

Here are some examples of ordinary and necessary business expenses that are deductible:

  • Administrative expenses such as licenses, insurance and accounting.
  • Office supplies to support your business
  • Lawyer and accountant fees
  • employee compensation
  • Employee-sponsored retirement plans, such as 401(k)
  • office space rental
  • bank charges
  • Commissions and costs of sale
  • Contract Labor Costs
  • Fees and subscriptions
  • Shipping and shipping costs
  • equipment rental
  • Software
  • Utilities
  • Publicity and promotion
  • Internet subscriptions, domain names and hosting

Bottom line

Simply put, business expenses that are not ordinary and necessary for your business cannot be deducted. Additionally, in the broad ordinary and necessary test, there are several types of expenses that are explicitly declared nondeductible in the tax code, including entertainment, taxes, penalties and fines, political contributions, and capital expenditures.

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