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Financial Planning > Tax Planning > Tax Deductions

3 Key Tax Rules Governing Typical Business Deductions

By Tax Facts Online

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What is a business expense deduction?

A business expense deduction is a deduction allowed for ordinary and necessary expenses paid or incurred in connection with an individual’s trade, business or profession. IRC Section 62(a)(1) operates to assure that all trade or business expenses, deductible as delineated under specific IRC Sections, are effectively allowed as above-the-line deductions, rather than itemized deductions. In the case of a sole proprietor, all but a few of these expenses are deducted in Schedule C of Form 1040.

For purposes of determining whether an expense may be deducted as a business expense, an expense is considered to be “ordinary” if it is one that is commonly incurred in the trade or occupation of the taxpayer. An expense is “necessary” if it is found to be appropriate or helpful to the taxpayer’s business or occupation. Among the common expenses in this category are: employees’ salaries; office rent; interest on business loans; the cost of supplies and utilities; traveling; entertainment; advertising; and automobile expenses.

Generally, business expenses of a self-employed individual (sole proprietor, independent contractor, or professional) may be deducted from gross income to arrive at adjusted gross income. The deductions are taken on Schedule C of Form 1040 in computing the net gain or loss from the taxpayer’s business or profession.

Can a taxpayer deduct business-related transportation expenses incurred when the taxpayer is not travelling away from home on business?

A taxpayer who is not considered to be “away from home” for purposes of deducting business-related travel expenses may still be entitled to claim a deduction forbusiness-related transportation expenses.A taxpayer is generally not entitled to deduct the cost of commuting from the taxpayer’sresidence to the taxpayer’sprimary place of business.However, business-related transportation costs other than commuting costs may be deducted as business expenses.Examples of such expenses include the following:

(1) Travelling from one business place to another business place within the general area that is considered a taxpayer’s “tax home;

(2) Visiting clients and customers;

(3) Travelling to a business meeting outside of the taxpayer’s principal place of business;

(4) Travel from the taxpayer’s residence to a temporary workplace if the taxpayer has one or more regular workplaces. A work location is considered temporary if it is realistically expected to last (and does last) for one year or less, unless the circumstances indicate otherwise.[1]

If a taxpayer’s residence is also the taxpayer’s principal place of business, that taxpayer may deduct the costs of commuting between the residence and another place of business, whether or not that second place of business is considered “regular” or “temporary.”

Example: Brent is a representative for a cheese manufacturing company and works out of his home.He has no permanent office, but regularly must drive to visit clients who have questions about his company’s cheese products.Brent may deduct the cost of driving between his home and client sites, even though these visits occur on a regular basis.If Brent were required to travel outside of his regular area of business on an overnight trip, those costs would be deductible as travel expenses, not transportation expenses.Because Brent travels by car, he can either deduct the actual costs of his car or the standard mileage rate for the year (57.5 cents per mile in 2015).[3]

As stated above, expenses incurred for commuting from the taxpayer’s residence to place of business are generally nondeductible. This is the case even though the taxpayer works during the commute—for example, by taking work-related calls or discussing business while carpooling with a business associate.

When is a taxpayer entitled to deduct moving expenses?

If certain conditions are met, a taxpayer may deduct reasonable moving expenses incurred in connection with beginning work at a new principal place of business, whether as an employee or self-employed person.The following general requirements apply:

(1) The taxpayer must have incurred moving expenses;

(2) Those moving expenses must be related to the taxpayer’s start of work at a new principal place of work;

(3) The taxpayer’s new principal place of work must be at least 50 miles further from his principal residence than the former principal place of work or, if the taxpayer had no former principal place of work, at least 50 miles from the former residence; and

(4) The taxpayer must work in the general location of the new principal place of work for a specified period. Specifically, this means that the taxpayer is either:

-a full-time employee in the general location of the new principal place of work for at least 39 weeks during the 12-month period following his or her arrival or,

-in the 24-month period followingarrival, a full-time employee or self-employed individual (on a full-time basis) in the general location of the new principal place of work during at least 78 weeks (39 weeks must be in the first 12-month period).

For moving expenses that meet the requirements above to be “qualified,” and thus deductible, they must relate to the expenses described below. “Qualified moving expenses” are:

(1) the costs incurred to move the taxpayer’s household items from the first location to the second location; and

(2) the travel expenses (excluding meals, but including lodging) incurred by the taxpayer in travelling from the first location to the second location.

The expenses described in (1), above, may include costs such as those related to packing, disconnecting and connecting utilities, and in-transit storage and insurance if incurred in the 30 day period after moving the goods from the taxpayer’s former residence. The IRS specifically excludes costs such as losses sustained upon ending membership in clubs, wasted tuition fees, costs incurred in buying property or losses sustained upon selling property because of the move.

Travel expenses described in (2), above, must be reasonable based on the facts and circumstances of the particular situation.Though the route travelled must usually be the shortest and most direct route, the taxpayer does not lose the deduction if the taxpayer incurs expenses that increase the cost of the move and are personal in nature.Instead, the deduction is reduced by the additional costs incurred for personal reasons.[6]The deduction is further reduced by any expenses deemed to be lavish or extravagant under the circumstances.

Example: Jeff is moving from Michigan to California for business reasons.He intends to drive but, rather than directly making the trip, he decides to stop and visit friends in St. Louis and Las Vegas along the way.Jeff is entitled to deduct the cost of moving from Michigan to California, minus any additional costs he incurs while visiting friends in other cities for personal reasons.

A taxpayer is also entitled to deduct the moving expenses of other members of the household, provided that the household member’s principal place of residence was both at the first location and at the second location.

Generally, moving expenses are treated as an “above the line” deduction; thus, if allowable, such expenses are deductible directly from gross income.

Is a taxpayer entitled to claim a deduction for business-related education expenses?

An employee is generally entitled to deduct education-related expenses that meet the following requirements:

(1) The expense must relate to education that is designed to maintain or improve skills used by the taxpayer in his or her trade or business; or

(2) The education must be specifically required by the employer, or under applicable law or regulations, in order for the taxpayer to retain an established employment relationship, status or compensation level.

Despite this, educational expenses will be considered personal, nondeductible expenses if:

(1) The expense is incurred in obtaining the minimum educational requirements for qualification in the taxpayer’s business (for example, obtaining a law degree) though, once the employee has met the minimum educational standards upon entering his trade or business, he will be treated as continuing to meet those standards even if they are eventually changed;

(2) The expense is incurred in obtaining education that will qualify the taxpayer for entering a new trade or business.A “change of duties” does not constitute a new trade or business if the new duties involve the same general type of workinvolved in the taxpayer’s present employment.  

Example: Annelise is an elementary school teacher and, during the course of her employment, takes the classes necessary to qualify as a secondary school teacher.The educational expenses are deductible because they do not qualify Annelise for entering a new trade or business.Her husband, Kevin, is self-employed as an accountant and taking law school courses in the evenings. Kevin’s education expenses are nondeductible, because they qualify him for entering a new trade or business.

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