As organizations launch into the new year, reestablishing certain financial standards, such as policies for business versus personal expenses, can help set clear expectations and ensure company-wide compliance. Read on for an overview of what is considered a business charge compared to a personal expenditure.
A business expense is considered deductible if it is:
- Related to a trade or business – For an expense to be related to a trade or business, the activities must rise to the level of a trade or business, and there must be a connection between the activities and the expense. For the activities to rise to the level of a trade or business, you must enter into the activity for the purpose of making a profit, and the activity must be substantial and sustained.
- Ordinary and necessary – An expense is considered ordinary if it is normal, usual or customary for the type of business in which it is incurred. An expense is necessary if it is appropriate or helpful to the business. An expense does not have to be indispensable to be considered necessary. In addition, the expense must be reasonable and not considered lavish.
- Paid or incurred while carrying on a trade or business – An individual is carrying on a trade or business only if they are actively engaged in that trade or business. Consequently, expenses relating to looking for a new trade or business, preparing for a new trade or business, or investigating the potential success of a new trade or business are not deductible as ordinary and necessary business expenses. However, such expenses may, through an election, be deducted by up to $5,000 and then amortized over a 15-year period as start-up expenditures.
Certain trade or business expenses are not deductible, even if they satisfy these tests. For example, expenses that violate public policy, such as bribes, are not deductible. In addition, expenditures for capital assets are not deductible, though a depreciation, amortization or depletion deduction may be allowed.
According to the criteria outlined above, business expenses can include, but are not limited to, the following:
- Business travel
- Business meals
- Supplies (copy paper, postage, printing, etc.)
- Office expenses (water machine, coffee/refreshments for employees/guests, etc.)
- Rental expenses
- Other expenses ordinary and necessary to run a trade or business
There are numerous expenditures that an individual makes for themselves that are individual in nature. An individual incurs many expenses that relate directly to caring for themself, which are nondeductible personal expenses. Thus, expenses for grooming, cosmetics and wardrobe (suitable for street/everyday wear) are considered personal. Commuting to and from work is also considered a personal expense and is not deductible.
If there is an expense that is used both for business and personal purposes, that expense can be divided between the two types of expenses. The most common example of this expense is an auto-related charge.
Some of the deduction rules are complex and require informed judgment to determine whether a particular expense is deductible. Therefore, the facts and circumstances of a particular situation should be carefully reviewed. Learn more about SST’s tax services, or contact our experts to further discuss the implications of a specific transaction.
Special thanks to Tax Supervisor Christina Nichols Morris for providing the content for this post.