Can I deduct my meals as a business expense? Can I deduct this flight as a business expense? Can I deduct the cost of my clothes or uniform as a business expense?
As a tax attorney, these are common questions I am asked, and rightfully so as everyone wants to take advantage of all potential deductions allowed by the Internal Revenue Code. Not only is the deductibility of certain business expenses a hot topic with business owners, but it is also a hot topic and highly litigated topic with the Internal Revenue Service. In fact, I recall reading a recent annual report to Congress by the Taxpayer Advocate Service whereby the deductibility of trade or business expenses he been one of the top ten most litigates issues for a very long time. Furthermore, the same report stated that the courts affirmed the position taken by the Internal Revenue Service (the disallowance of the deduction) in the vast majority of cases and that the taxpayer only prevailed (in full) about two percent (2%) of the time. The article below is not intended to be legal advice, but rather to provide general information regarding this issue.
First and foremost, we should start with the current law regarding deductions for business expenses. Internal Revenue Code (the “Code”) Section 162 allows deductions for ordinary and necessary expenses incurred in a business or trade. What actually constitutes ordinary and necessary may better be understood through an analysis of the case law, which is significant, surrounding the question. Generally, the determination is made based upon a court’s full review of all facts and circumstances.
Based upon the black and white law under the Code, what constitutes a trade or business for purposes of Section 162. Perhaps it is ironic that the term “trade or business” is so widely used in the Code, but yet, neither the Code nor the Treasury Regulations provide a definition for Trade or Business. Personally, I think it would be quite hard to provide a definition for trade or business, especially under the auspices of income tax. The concept of trade or business has been refined and defined by the courts more so than the Code. The United States Supreme Court has held and stated that a trade or business is an activity conducted with continuity and regularity, and with the primary purpose of earning a profit. Albeit broad, I would agree this definition would be sufficient for the majority of businesses I work and assist.
Now that we have an idea of what may constitute a trade or business, what is “ordinary and necessary?” Again, the Supreme Court has helped provide definitions for these broad, but important terms. Ordinary has been defined as customary or usual and of common or frequent occurrence in the trade or business. Necessary has been defined as an expense that is appropriate and helpful for the development of the business. Further, it should be noted that some courts have also applied a level of reasonableness to each expense.
John McGuire is a tax attorney and business attorney at The McGuire Law Firm focusing his practice on issues before the IRS, tax planning & analysis, and business transactions from formation to sale.