8. Business Expenses

Introduction

You can deduct the costs of running your business. These costs are known as business expenses. These are costs you do not have to capitalize or include in the cost of goods sold.

To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of 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.

For more information about the general rules for deducting business expenses, see chapter 1 in Publication 535, Business Expenses.

If you have an expense that is partly for business and partly personal, separate the personal part from the business part.

Useful Items You may want to see:

Publication

• 535   Business Expenses

See chapter 12 for information about getting publications and forms.

Bad Debts

If someone owes you money you cannot collect, you have a bad debt. There are two kinds of bad debts - business bad debts and nonbusiness bad debts.

A business bad debt is generally one that comes from operating your trade or business. You can deduct business bad debts as an expense on your business tax return.

Business bad debt.   A business bad debt is a loss from the worthlessness of a debt that was either of the following.

1. Created or acquired in your business.
2. Closely related to your business when it became partly or totally worthless.

A debt is closely related to your business if your primary motive for incurring the debt is a business reason.

Business bad debts are mainly the result of credit sales to customers. They can also be the result of loans to suppliers, clients, employees, or distributors. Goods and services customers have not paid for are shown in your books as either accounts receivable or notes receivable. If you are unable to collect any part of these accounts or notes receivable, the uncollectible part is a business bad debt.

You can take a bad debt deduction for these accounts and notes receivable only if the amount owed you was included in your gross income either for the year the deduction is claimed or for a prior year.

Accrual method.   If you use an accrual method of accounting, you normally report income as you earn it. You can take a bad debt deduction for an uncollectible receivable if you have included the uncollectible amount in income.

Cash method.   If you use the cash method of accounting, you normally report income when you receive payment. You cannot take a bad debt deduction for amounts owed to you that you have not received and cannot collect if you never included those amounts in income.

More information.   For more information about business bad debts, see chapter 11 in Publication 535.

Nonbusiness bad debts.   All other bad debts are nonbusiness bad debts and deductible as short-term capital losses on Schedule D (Form 1040). For more information on nonbusiness bad debts, see Publication 550, Investment Income and Expenses.

Car and Truck Expenses

If you use your car or truck in your business, you may be able to deduct the costs of operating and maintaining your vehicle. You also may be able to deduct other costs of local transportation and traveling away from home overnight on business.

You may be entitled to a tax credit for an electric vehicle or a deduction from gross income for a part of the cost of a clean-fuel vehicle you place in service during the year. The vehicle must meet certain requirements and you do not have to use it in your business to qualify for the credit or the deduction. For more information, see chapter 12 in Publication 535.

Local transportation expenses.   Local transportation expenses include the ordinary and necessary costs of all the following.

• Getting from one workplace to another in the course of your business or profession when you are traveling within the city or general area that is your tax home. Tax home is defined later.
• Visiting clients or customers.
• Going to a business meeting away from your regular workplace.
• Getting from your home to a temporary workplace when you have one or more regular places of work. These temporary workplaces can be either within the area of your tax home or outside that area.

Local business transportation does not include expenses you have while traveling away from home overnight. Those expenses are deductible as travel expenses and are discussed later under Travel, Meals, and Entertainment. However, if you use your car while traveling away from home overnight, use the rules in this section to figure your car expense deduction.

Generally, your tax home is your regular place of business, regardless of where you maintain your family home. It includes the entire city or general area in which your business or work is located.

Example.   You operate a printing business out of rented office space. You use your van to deliver completed jobs to your customers. You can deduct the cost of round-trip transportation between your customers and your print shop.

You cannot deduct the costs of driving your car or truck between your home and your main or regular workplace. These costs are personal commuting expenses.

Office in the home.   Your workplace can be your home if you have an office in your home that qualifies as your principal place of business. See Business Use of Your Home, later.

Example.   You are a graphics designer. You operate your business out of your home. Your home qualifies as your principal place of business. You occasionally have to drive to your clients to deliver your completed work. You can deduct the cost of the round-trip transportation between your home and your clients.

Methods for Deducting Car and Truck Expenses

For local transportation or overnight travel by car or truck, you generally can use one of the following methods to figure your expenses.

• Standard mileage rate.
• Actual expenses.

Standard mileage rate.   You may be able to use the standard mileage rate to figure the deductible costs of operating your car, van, pickup, or panel truck for business purposes. For 2002, the standard mileage rate is 36½ cents a mile for all business miles.

If you choose to use the standard mileage rate for a year, you cannot deduct your actual expenses for that year except for business-related parking fees and tolls.

Choosing the standard mileage rate.   If you want to use the standard mileage rate for a car or truck you own, you must choose to use it in the first year the car is available for use in your business. In later years, you can choose to use either the standard mileage rate or actual expenses.

If you want to use the standard mileage rate for a car you lease, you must choose to use it for the entire lease period (including renewals).

Standard mileage rate not allowed.   You cannot use the standard mileage rate if you:

1. Use the car for hire (such as a taxi),
2. Operate two or more cars at the same time,
3. Claimed a depreciation deduction using any method other than straight line, for example, ACRS or MACRS,
4. Claimed a section 179 deduction on the car,
5. Claimed the special depreciation allowance on the car,
6. Claimed actual car expenses for a car you leased, or
7. Are a rural mail carrier who received a qualified reimbursement.

Parking fees and tolls.   In addition to using the standard mileage rate, you can deduct any business-related parking fees and tolls. (Parking fees you pay to park your car at your place of work are nondeductible commuting expenses.)

Actual expenses.   If you do not choose to use the standard mileage rate, you may be able to deduct your actual car or truck expenses.

If you qualify to use both methods, figure your deduction both ways to see which gives you a larger deduction.

Actual car expenses include the costs of the following items.

Depreciation	Lease payments	Registration
Garage rent	Licenses	Repairs
Gas	Oil	Tires
Insurance	Parking fees	Tolls

If you use your vehicle for both business and personal purposes, you must divide your expenses between business and personal use. You can divide your expenses based on the miles driven for each purpose.

Example.   You are the sole proprietor of a flower shop. You drove your van 20,000 miles during the year. 16,000 miles were for delivering flowers to customers and 4,000 miles were for personal use. You can claim only 80% (16,000 ÷ 20,000) of the cost of operating your van as a business expense.

More information.   For more information about the rules for claiming car and truck expenses, see Publication 463, Travel, Entertainment, Gift, and Car Expenses.

Reimbursing Your Employees for Expenses

You generally can deduct the amount you reimburse your employees for car and truck expenses. The reimbursement you deduct and the manner in which you deduct it depend in part on whether you reimburse the expenses under an accountable plan or a nonaccountable plan. For details, see chapter 13 in Publication 535. That chapter explains accountable and nonaccountable plans and tells you whether to report the reimbursement on your employee's Form W-2, Wage and Tax Statement.

Depreciation

If property you acquire to use in your business is expected to last more than one year, you generally cannot deduct the entire cost as a business expense in the year you acquire it. You must spread the cost over more than one tax year and deduct part of it each year on Schedule C or C-EZ. This method of deducting the cost of business property is called depreciation.

The discussion here is brief. You will find more information about depreciation in Publication 946, How To Depreciate Property.

What property can be depreciated?   You can depreciate property if it meets all the following requirements.

• It must be property you own.
• It must be used in business or held to produce income. You never can depreciate inventory (explained in chapter 2) because it is not held for use in your business.
• It must have a useful life that extends substantially beyond the year it is placed in service.
• It must have a determinable useful life, which means that it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes. You never can depreciate the cost of land because land does not wear out, become obsolete, or get used up.
• It must not be excepted property. This includes property placed in service and disposed of in the same year.

Repairs.   You cannot depreciate repairs and replacements that do not increase the value of your property, make it more useful, or lengthen its useful life. You can deduct these amounts on line 21 of Schedule C or line 2 of Schedule C-EZ.

Depreciation method.   The method for depreciating most business and investment property placed in service after 1986 is called the Modified Accelerated Cost Recovery System (MACRS). MACRS is discussed in detail in Publication 946.

Section 179 deduction.   You can choose to deduct a limited amount of the cost of certain depreciable property in the year you place the property in service. This deduction is known as the section 179 deduction. For more information, see Publication 946. It explains what property qualifies for the deduction, what limits apply to the deduction, and when and how to recapture the deduction.

Special depreciation allowance.   You can take a special depreciation allowance of 30% of the cost of qualified property for the year the property is placed in service. For more information, see Publication 946.

Listed property.   Listed property is any of the following.

• Most passenger automobiles.
• Most other property used for transportation.
• Any property of a type generally used for entertainment, recreation, or amusement.
• Certain computer and related peripheral equipment.
• Any cellular telephone (or similar telecommunications equipment).

You must follow special rules and recordkeeping requirements when depreciating listed property. For more information about listed property, see Publication 946.

Form 4562.   Use Form 4562, Depreciation and Amortization, if you are claiming any of the following.

• Depreciation on property placed in service during the current tax year.
• A section 179 deduction.
• Depreciation on any listed property (regardless of when it was placed in service).

If you have to use Form 4562, you must file Schedule C. You cannot use Schedule C-EZ.

Employees' Pay

You can generally deduct on Schedule C the pay you give your employees for the services they perform for your business. The pay may be in cash, property, or services.

To be deductible, your employees' pay must be an ordinary and necessary expense and you must pay or incur it in the tax year. In addition, the pay must meet both the following tests.

• The pay must be reasonable.
• The pay must be for services performed.

Chapter 2 in Publication 535 explains and defines these requirements.

You cannot deduct your own salary or any personal withdrawals you make from your business. You are not an employee of the business.

If you had employees during the year, you must use Schedule C. You cannot use Schedule C-EZ.

Kinds of pay.   Some of the ways you may provide pay to your employees are listed below. For an explanation of each of these items, see chapter 2 in Publication 535.

• Awards.
• Bonuses.
• Education expenses.
• Fringe benefits (discussed later).
• Loans or advances you do not expect the employee to repay if they are for personal services actually performed.
• Property you transfer to an employee as payment for services.
• Reimbursements for employee business expenses.
• Sick pay.
• Vacation pay.

Fringe benefits.   A fringe benefit is a form of pay provided to any person for the performance of services by that person. The following are examples of fringe benefits.

• Benefits under qualified employee benefit programs.
• Meals and lodging.
• The use of a car.
• Flights on airplanes.
• Discounts on property or services.
• Memberships in country clubs or other social clubs.
• Tickets to entertainment or sporting events.

Employee benefit programs include the following.

• Accident and health plans.
• Adoption assistance.
• Cafeteria plans.
• Dependent care assistance.
• Educational assistance.
• Group-term life insurance coverage.
• Welfare benefit funds.

You can generally deduct the cost of fringe benefits you provide on your Schedule C in whatever category the cost falls. For example, if you allow an employee to use a car or other property you lease, deduct the cost of the lease as a rent or lease expense. If you own the property, include your deduction for its cost or other basis as a section 179 deduction or a depreciation deduction.

You may be able to exclude all or part of the fringe benefits you provide from your employees' wages. For more information about fringe benefits and the exclusion of benefits, see Publication 15-B, Employer's Tax Guide to Fringe Benefits.

Previous | First | Next

Publication Index | 2002 Tax Help Archives | Tax Help Archives | Home