Think Knowing What Is Tax Deductible In Business Is Obvious? Not So Fast.
5 minute read time
Cynthia Hess, stage name Chesty Love, was in the entertainment industry during the 1980s and 1990s. She discovered that the larger her chest size got, the bigger her tips grew. Over the years she added to her bust size though plastic surgery and in 1988 she claimed a $2,088 deduction for her breast surgery she paid for that year on her income tax return. The IRS disallowed the deduction so Chesty appealed the decision in tax court. Representing herself she was able to convince the tax court that her plastic surgery was ordinary and necessary for the production of income in her industry. What the IRS could not refute was the fact that Chesty’s income did go up after the surgery which buttressed her position that larger breasts were needed in order for her to earn additional income. This satisfied the definition the IRS came up with for a legitimate tax deduction. Translation – A stripper with 56FF breasts weighing 20 lbs. out-witted the IRS using the rules the IRS set up themselves.
I often advise bookkeepers and controllers on questionable deductions and how they should treat them on their Profit & Loss Statement. I noticed that they would often times use their own moral compass in order to conclude what was deductible or not. For instance, a controller wanted me to side with her that the owner’s entertainment expense of going to a topless establishment was not deductible. That’s when it hit me. She was rationalizing the expense as non-deductible because she didn’t agree with this type of entertainment based on her personal values instead of thinking in terms of how the IRS defines what is and what isn’t deductible.
The IRS definition of what qualifies as a business deduction is rather vague actually. The IRS states that a business can take a deduction for any expense that is ordinary and necessary in carrying on any trade or business. That leaves a lot of room for interpretation, don’t you think? Let’s break down the vague terms of ordinary and necessary separately.
Ordinary expenses are ones that are normal, common, and in line with industry standards. Necessary expenses are ones that are appropriate and helpful for your business. Let’s use an example to illustrate. The construction industry is dominated by mostly men. Many of them enjoy going to topless bars and would rather conduct business there as opposed to the opera. This is in line with this specific industry’s standards and if it helps develop and nurture business relations with others in their industry then according to the IRS standards this type of entertainment is deductible. I should mention that business matters must be discussed either before, during, or after going to entertainment facilities in order to be deductible.
The reason any of this is even important is because every dollar of expense helps reduce taxable income which reduces the overall income tax bill. Determining what can be tax deductible for business purposes isn’t an exercise in moral correctness. Of course if the expense is for something illegal then obviously it can’t be deducted. That’s why a drug dealer is required to report all their income but is not allowed to deduct any cost of goods sold expense for the purchase price or manufacturing of the drugs since the drugs themselves are illegal. And we all know any good drug dealer is sure to report all of their income.
When meeting with new entrepreneurs I’m often asked what can be deducted in their business. Usually what they are really asking is what hidden deductions are there that they should know about. It’s helpful to understand that general expenses that are directly related to the business are absolutely deductible. If a restaurant sells sandwiches then the cost of the bread, lettuce, tomato, meat, condiments, silverware, labor to make the sandwich, rent, utilities, insurance are all 100% deductible. That may seem obvious but we need a starting point and one that’s obvious is the best place to start.
For a comprehensive list of just about any business expense you can think of, I’ve included a list under the Free Resources Tab on my website www.BusinessStreetSmarts.com. It’s labeled “List of Common Business Expenses”.
Genius…is the capacity to see ten things where the ordinary man sees one.