Almost all of your outlays for business are going to be deductible. However, there may be limitations on how much you can deduct, there may be timing issues on when you can take the deduction, and in some cases, the expenses result in a tax credit rather than a deduction (see Chapter 9). And in all cases you need to have proof of the expense by keeping good records.

Within this chapter are a range of the most common types of business deductions, which are the ones you're most likely to experience. However, they are not necessarily the only deductions you can take. There is a general rule in tax law that you can deduct expenses for your business that are ordinary and necessary. An ordinary expense is one that is common and accepted in your business. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be indispensable to be considered necessary.

In many cases, there is a specific line on Schedule C for entering the amount of the deductible expense. For example, you'll find lines for advertising, interest, legal and professional fees, taxes and licenses, and utilities. If there is no appropriate line for a deductible expense, it is listed in Part V of Schedule C, called “other expenses.”

You may be eligible for a special personal deduction based on your business income. This deduction, called the qualified business income (QBI) deduction, is explained in Chapter 10.

There are instances where expenses are not deductible. You'll find a checklist of nondeductible items at the end of this chapter.

Advertising Costs

You may employ a variety of advertising and promotional strategies to help you attract and retain customers. For the most part, all of your costs are deductible in full for the year in which they are paid.

Bad Debts

If money you are owed is not paid, you have a bad debt. There are two kinds of bad debts, each of which has different tax treatment:

1. Business bad debts. These are debts created or acquired in your business, such as unpaid accounts receivable or unpaid loans you've made to customers, clients, employees, suppliers, or distributors. Business bad debts usually become deductible when it's determined that they are partially or wholly worthless. However, as a cash basis business, you cannot deduct unpaid receivables because you never reported them as income in the first place.
2. Nonbusiness bad debts. All other debts are nonbusiness bad debts. They are deductible as short-term capital losses on Form 8949 and Schedule D of Form 1040 or 1040-SR. They must be wholly worthless to be deductible and do not produce any business write-off.

Banking Fees

You may be charged fees for your business bank account. The fees may relate to deposits, checks issued, and balances that fall below set levels in the month. You may also have an annual fee for a business credit card or fees for using ATM machines. All of these costs are deductible business expenses.

Which type of business credit card is best for your situation? There are dozens of options. Do you want cash-backs, frequent-flyer miles, or other rewards? Do you pay your balance in full or plan to use your card for financing business purchases? Comparison shop for the best business credit card that meets your needs at sites such as CreditCards.com, LowCards.com, and NerdWallet.com.

Casualty and Theft Losses

Bad things happen no matter how much you prepare and plan for the best. A fire can destroy your equipment. A power outage can spoil the food in your refrigerators for your catering business. Your laptop may be stolen in the airport. Whatever the reason for your loss, the tax laws provide some relief.

You can take a full tax deduction on Schedule C for any casualty or theft loss that is not covered by insurance. Unlike the deduction for a personal casualty and theft loss, which is subject to limitations (e.g., losses must be occasioned by a federally declared disaster to be partially deductible), there are no limitations for these business losses.

Be sure to retain proof of loss, such as photos of property damage and police reports for thefts.

Charitable Contributions

Go ahead, be generous. You'll help your favorite causes and may get a tax deduction for your donations. However, the write-off is not a business expense, even if the donation was solicited from your business and you wrote a check to the charity from your business bank account. The deduction can only be claimed as a personal itemized deduction on Schedule A of your Form 1040 or 1040-SR.

Here are some special rules to help you figure what you can write off:

• You can deduct cash donations up to 60% of your adjusted gross income. The percentage is scheduled to decline to 50% after 2025, unless Congress changes the law.
• Donations of property held more than one year are usually deductible up to 30% of your adjusted gross income.
• Out-of-pocket expenses are deductible. If you incur costs to help a charity and are not reimbursed, you can deduct these costs. If you drive for charitable purposes, you can include mileage at a fixed rate of 14¢ per mile, plus parking and tolls.
• Donations made near the end of the year by credit card are deductible when the charge is made even if the credit card bill is paid in the following year.
• Donations made near the end of the year by checks that are mailed are deductible when mailed even though the charity receives the donations in the following year, provided there are sufficient funds on hand to honor the checks.
• Deductions for donations of intellectual property, such as patents, copyrights, and trademarks, are limited to the lesser of your basis in the property or its fair market value on the date of the donation. In some cases, your basis may be zero or only a modest amount, so little or no deduction can be claimed. However, you are permitted to take an additional deduction based on the amount of income derived by the charity from your donation, according to Table 7.1. Thus, if you are a songwriter and give the copyright to one of your songs to a charity and it receives royalties, you can take a charitable deduction based on this income.

No deduction can be claimed after the legal life of the intellectual property ends or after the 12th anniversary of the donation, whichever happens first. When you donate intellectual property to a charity, inform the charity that you intend to claim this deduction. It will then file Form 8899, Notice of Income from Donated Intellectual Property, showing the income it derived from the property so you can figure your deduction.

Dues

Dues related to your business may or may not be deductible. Those that are deductible are allowed without any dollar limit or other qualification.

Deductible dues are amounts paid to the following professional, business, or civic organizations:

• American Bar Association, American Institute of CPAs, American Medical Association, and other professional associations
• Chambers of commerce, business leagues, trade associations, boards of trade, real estate boards, and business lunch clubs
• Civitan, Rotary, Lions, and other civic organizations

No deduction is allowed for dues paid to the following, even though you join for business and business may be conducted there:

• Airline clubs
• Athletic and sporting clubs, including gyms, golf courses, and tennis clubs
• Hotel clubs
• Recreational clubs

Education Expenses

As Benjamin Franklin said, “an investment in knowledge pays the best interest.” Education can help you improve your business abilities and contribute to higher earnings. Education costs may be a deductible business expense on Schedule C if the courses are primarily undertaken to:

• Maintain or improve skills required in your business. If you take a sales course to help you better attract and retain customers, you likely meet this condition.
• Meet the requirements of applicable law or regulations. If you are a professional, continuing education courses meet this condition.

Even though education of any kind can be helpful in personal growth and translate into some business benefit, not every education course is deductible. You cannot deduct the cost of education needed to meet minimum educational requirements, such as the cost of obtaining any professional degree in law, accounting, medicine, or dentistry. Also you cannot deduct the cost of education that qualifies you for a new trade or business. Thus, the cost of going back to school to learn graphic design is not deductible.

Impairment-Related Expenses

Some self-employed individuals operate successful businesses despite having disabilities. Such individuals may incur special costs that enable them to work. The costs are deductible, but the question is whether they are business deductions on Schedule C or itemized medical costs on Schedule A of Form 1040 or 1040-SR.

If the cost is for a service or item that is used for work, likely the cost will be a deductible business expense. For example, an attendant who accompanies a self-employed person to work at the office usually is viewed as a business expense. Special equipment to help those who are hearing or sight impaired can also be business costs. However, if the items are expected to last beyond one year, the cost can be expensed or recovered through deduction (see Chapter 6 for an explanation with respect to furniture and fixtures).

Interest

Interest you pay on a bank loan, a business credit card, or other business-related debt is tax deductible. There is no dollar limit or other qualification to meet. Full deductibility applies only for a “small business.” This is one with average annual gross receipts in the three prior years below a set limit ($26 million in 2019), as well as farming businesses and real property businesses that elect this rule. Because most Schedule C service providers are small businesses, the limitation on businesses that don't qualify for full deductibility is not discussed further here. This is a convoluted way of saying your business interest expense is fully deductible.

Legal and Professional Fees

It's good business practice to use the best professional advice you can, but this costs money. In most cases, these fees are ordinary and necessary business expenses that you deduct for the year in which they are paid.

Examples of currently deductible legal fees include:

• Assistance in collecting outstanding accounts payable
• Defending against a claim of infringement of intellectual property
• Obtaining an IRS ruling
• Tax advice

You cannot deduct these legal fees:

• Legal fees for personal purposes, such as preparing your will, even if it contains provisions affecting your business.
• Legal fees paid in connection with acquiring property. Thus, fees you pay to a lawyer when you buy a commercial building are not deductible. Instead, they are added to the basis of the building and will be recovered through depreciation allowances.

Accounting fees for business-related tax advice or representation before the IRS concerning a business matter are usually currently deductible. A fee for tax return preparation must be allocated between the costs related to Schedule C, which are deductible as a business expense, and the costs related to your personal return, which are not deductible in 2018 through 2025 due to the suspension of miscellaneous itemized deductions subject to the 2% of adjusted gross income floor on Schedule A.

Licenses and Regulatory Fees

Depending on what you do, you may be required to have a license or pay a fee to operate your business legally (see Chapter 2). If you obtain licenses and permits for your business, the cost is usually deductible in full; there are no limitations. However, you can't deduct:

• Licenses for a vehicle used in business if you use the standard mileage rate (see Chapter 5)
• Permits for the construction of realty, which are a capital cost added to the basis of the property and recovered through depreciation

Materials and Supplies

Office supplies and cleaning supplies are deductible without any dollar limit or complication. If you are a qualified “small business,” you can treat inventory items sold to customers when you provide services as non-incidental material and supplies. Material and supplies, both incidental and non-incidental, are discussed in Chapter 6.

Moving Expenses

If you relocate your home, you can't deduct the cost of moving your household items (the personal deduction for work-related moves is suspended from 2018 through 2025 for other than military personnel).

But the cost of a business move is deductible. If you stay in your home but move your office, you can deduct all of the related costs as a business expense. For example, you hire a van to move your office furniture and equipment from your current office to a new one. The cost of the van rental, plus packing supplies to wrap your items for the move, is deductible on Schedule C.

Payments for Outsourced Workers

When you start your business, you may handle every aspect of your activities, from sales to bookkeeping to web design. As your business grows you may want to outsource some of the work so you can do more of what you're best at. The fees and charges you pay to engage workers who are not your employees are fully deductible. These people are independent contractors or employees of the agencies that find them work.

Penalties, Fines, and Damages

No one is perfect and things happen. Some are unintentional; others are deliberate. Regardless of motive, you may be able to deduct certain penalties, fines, and damages, but others are nondeductible. Here's a sampling of those that are deductible:

• Damages paid that result from a lawsuit you lose. For example, if someone sues you for breach of contract and you lose, the court-awarded damages are deductible. If you have insurance and the policy covers part of the damage award, you deduct the balance.
• Penalty for noncompliance or lateness in the performance of contract work is deductible. In the future, you may be able to avoid a penalty by carrying a performance bond that protects the party you're working for from poor or late work.
• Restitution payments that are compensatory in nature and are not viewed as punitive (i.e., paid in lieu of a prison sentence).

No deduction can be taken for fines or penalties imposed by the government because you broke the law. Here are some examples of nondeductible fines and penalties:

• Amounts paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation or inquiry by such government or entity into the potential violation of any law.
• Fines by truckers for violating state highway maximum weight limits or air quality laws
• Parking tickets
• Penalties related to income, sales, or other taxes imposed by federal, state, or local law

Repayment of Income

If you reported income on your return but later repay it, you can deduct the repayment. For example, if you reported a fee of $10,000 from a customer this year, but next year the customer raises a problem and you refund $2,000, you can deduct the $2,000 on next year's return (the year in which the repayment is made). You don't have to file an amended return for this year to back out the income.

If the amount of the repayment exceeds $3,000, you have a choice between taking a deduction or a tax credit. Re-compute your income for the year in which you received the initial payment by subtracting the amount repaid and figure the tax on your income for the year. Compare that tax with the amount you actually paid. The difference is a tax credit for the year of repayment. Figure your tax savings using both methods and choose the one that gives you a greater tax savings.

Startup Costs

Before you actually start a business, you may incur a variety of expenses. Ordinarily these expenses would not be deductible because you aren't in business yet. Normally they would be treated as capital expenditures to acquire a capital asset, namely your business. However, the tax law lets you write off startup costs within set limits.

You can deduct startup costs up to $5,000 in the year in which you open your doors for business. Costs over this dollar limit can be deducted evenly over a period of 180 months. However, if startup costs exceed $50,000, you lose one dollar of the upfront deduction for each one dollar over $50,000; no upfront deduction is allowed if startup costs exceed $55,000. However, they can all be deducted evenly (called amortized) over 180 months.

Subscriptions

The cost of subscriptions to business or professional publications is deductible on Schedule C. However, if you prepay subscriptions that run more than a year, you can only deduct the portion of the cost that relates to one year. You then deduct the allocation portion of the subscription in next year and the next.

Supplies

Paperclips, cleaning supplies, and toners for your printer are examples of supplies you routinely have for your business. Supplies are discussed in Chapter 6.

Taxes

You may be able to deduct a variety of federal, state, local, and foreign taxes on Schedule C if they are directly attributable to your business. Here is a list of what you can and cannot deduct.

You can deduct the following (on Schedule C or elsewhere as noted):

• State tax on gross income (as opposed from tax on net income) that is directly attributable to your business is deductible on Schedule C.
• State and local income taxes on Schedule A of Form 1040 or 1040-SR (up to a total of $10,000, or $5,000 if married filing separately).
• Employment taxes you paid for employees, including the employer share of FICA, all of FUTA and state unemployment insurance, and any payments to a state disability fund on Schedule C.
• One-half of self-employment tax as an adjustment to gross income on Schedule 1 of Form 1040 or 1040-SR.
• Personal property tax imposed by your state or local government on personal property used in your business on Schedule C.
• Real estate taxes on business property you own is deductible on Schedule C.
• Excise taxes paid in the course of business are deductible on Schedule C.
• Foreign income and certain other foreign taxes paid by your business may be deductible on Schedule C. However, in some cases you can opt to take a foreign tax credit rather than a deduction.

You cannot deduct:

• Federal income tax, even the portion related to your profits on Schedule C.
• Sales tax paid on a service or property used in your business because such tax is part of the cost of the service or property and deducted as such.
• Fuel taxes on gasoline, diesel fuel, and other motor fuels used in your business are not deductible as separate items. They are part of the cost of fuel and deductible as such.

Utilities

Utilities for your office, Internet fees for online access, and costs for your mobile devices are all deductible. Utility costs are explained in Chapter 6.

Checklist of Nondeductible Expenses

Not every cost you incur is a deductible business expense. Here are some common items that you cannot write off:

• Bribes and kickbacks
• Dues to business, social, athletic, luncheon, sporting, airline, or hotel clubs
• Disability insurance for yourself
• Entertainment expenses
• Estimated tax penalties
• Extortion payments
• Gifts to business-related persons over $25 per year
• Half the cost of meals in most cases
• Lobbying expenses
• Personal, living, and family expenses
• Political contributions
• Spousal travel costs (other than amounts that would be incurred even if the spouse were not on the trip)
• Tax penalties

What's Ahead

You readily see that most business-related costs are deductible. But what if the costs are primarily for you and your protection?

In the next chapter you'll see that you can deduct the cost of medical coverage for you and your family. You'll also see that you can shelter your profits and ensure a financially secure future by using special retirement plans.