With recovery still a long way off and unemployment climbing, many small businesses are still struggling to stay afloat. For the small business, increasing the bottom line not only comes from cutting costs and widening margins in the sale of their products and services, it can also come from making sure the small business is deducting all of the legally allowed business expenses it can possibly find and legally apply.
Under the law, business expenses by definition include the total costs and expenses in operating a small business. Those costs and expenses can then be deducted against the profits of the business. Be careful however in distinguishing between a tax credit and a tax deduction. A tax deduction reduces the amount of taxable income subject to tax, while a tax credit directly offsets the small business tax burden, dollar-for-dollar, in the amount of the business credit. Tax credits for this reason are much more valuable for small businesses that are operating at a profit.
The Tax Code – Deducting Expenses (2009)
The tax code allows for small businesses to deduct the costs and expenses of doing business from its gross income in determining its tax burden. What is left constitutes the net profit of the small business and is the final amount that actually gets taxed.
For small business income to be deductible, a business expense must be both ordinary and necessary. An ordinary expense is defined as one that is common and customary in the type of small business that is operated. A necessary expense has been determined to be one that is both helpful and appropriate to the small business. Finally, an expense does not have to be indispensable for it to also be considered necessary under the tax code.
Determining whether an expense will be considered “ordinary and necessary” and therefore a permissible business deduction depends on the tax code and the courts that interpret it. For instance, computers and printers used in the operation of the business are considered legally deductible.
However some business expenses, such as business travel and lodging have been scrutinized in recent years and are not always legally deductible by the business. The issue often hinges on whether or not the IRS considers the expense ordinary and necessary to the operation of the business. However, this is not always clear– especially for example, where the goal of the small business trip is to develop future contacts and sales rather then just servicing existing business customers. Whether a business trip was taken for personal or business purposes is a chief concern for the IRS and is usually targeted as a questionable expense.
Fortunately, where the IRS code and its publications are silent as to whether an expense is to be considered an ordinary and necessary deduction, the courts must determine this issue on a case-by-case basis. The courts will look at the size of the expense deduction, its purpose, the custom and practice of like businesses to take such a business deduction, and finally, whether or not there is a reasonable business purpose behind the expense.
IRS auditors do not take kindly when a taxpayer’s personal expenses are being claimed or commingled with business expenses. For example, a taxpayer may not use the company car to take a personal vacation with the family and then try to expense the trip as a legitimate business expense.
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