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 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 may be able to 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.

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.

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.

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 2005, the standard mileage rate is 40.5 cents a mile for all business miles driven before September 1, 2005. The rate is 48.5 cents a mile for business miles driven after August 31, 2005, and before January 1, 2006.

  

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 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 five 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.

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. 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.

Section 179 deduction.   You can elect 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.” The maximum amount you can elect to deduct during 2005 is $105,000. This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $420,000. The total amount of depreciation (including the section 179 deduction) you can take for a passenger automobile you use in your business and first place in service in 2005 is $2,960. Special rules apply to electric vehicles and trucks and vans. 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.

  

Your section 179 election for the cost of any sport utility vehicle (SUV) and certain other vehicles is limited to $25,000. For more information, see the Instructions for Form 4562 or 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.

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.

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. As a sole proprietor, you are not an employee of the business.

Fringe benefits.   A fringe benefit is a form of pay for the performance of services. 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.

You can generally deduct premiums you pay for the following kinds of insurance related to your business.

You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your business. Interest relates to your business if you use the proceeds of the loan for a business expense. It does not matter what type of property secures the loan. You can deduct interest on a debt only if you meet all of the following requirements.

You cannot deduct on Schedule C or C-EZ the interest you paid on personal loans. If a loan is part business and part personal, you must divide the interest between the personal part and the business part.

Legal and professional fees, such as fees charged by accountants, that are ordinary and necessary expenses directly related to operating your business are deductible on Schedule C or C-EZ. However, you usually cannot deduct legal fees you pay to acquire business assets. Add them to the basis of the property.

If the fees include payments for work of a personal nature (such as making a will), you can take a business deduction only for the part of the fee related to your business. The personal part of legal fees for producing or collecting taxable income, doing or keeping your job, or for tax advice may be deductible on Schedule A (Form 1040) if you itemize deductions. For more information, see Publication 529, Miscellaneous Deductions.

You can set up and maintain the following small business retirement plans for yourself and your employees.

SEP, SIMPLE, and qualified plans offer you and your employees a tax favored way to save for retirement. You can deduct contributions you make to the plan for your employees on line 19 of Schedule C. If you are a sole proprietor, you can deduct contributions you make to the plan for yourself on line 28 of Form 1040. You can also deduct trustees' fees if contributions to the plan do not cover them. Earnings on the contributions are generally tax free until you or your employees receive distributions from the plan. You may also be able to claim a tax credit of 50% of the first $1,000 of qualified startup costs if you begin a new qualified defined benefit or defined contribution plan (including a 401(k) plan), SIMPLE plan, or simplified employee pension.

Under certain plans, employees can have you contribute limited amounts of their before-tax pay to a plan. These amounts (and earnings on them) are generally tax free until your employees receive distributions from the plan.

For more information on retirement plans for small business, see Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans).

Rent is any amount you pay for the use of property you do not own. In general, you can deduct rent as a business expense only if the rent is for property you use in your business. If you have or will receive equity in or title to the property, you cannot deduct the rent.

You can deduct on Schedule C or C-EZ various federal, state, local, and foreign taxes directly attributable to your business.

Sales tax.   Treat any sales tax you pay on a service or on the purchase or use of property as part of the cost of the service or property. If the service or the cost or use of the property is a deductible business expense, you can deduct the tax as part of that service or cost. If the property is merchandise bought for resale, the sales tax is part of the cost of the merchandise. If the property is depreciable, add the sales tax to the basis for depreciation. For information on the basis of property, see Publication 551, Basis of Assets.

  

Do not deduct state and local sales taxes imposed on the buyer that you must collect and pay over to the state or local government. Do not include these taxes in gross receipts or sales.

This section briefly explains the kinds of travel and entertainment expenses you can deduct on Schedule C or C-EZ.

To deduct expenses related to the part of your home used for business, you must meet specific requirements. Even then, your deduction may be limited.

To qualify to claim expenses for business use of your home, you must meet the following tests.

You may also be able to deduct the following expenses. See Publication 535 to find out whether you can deduct them.

You usually cannot deduct the following as business expenses. For more information, see Publication 535.