Business expenses are deductible for federal income tax purposes, whether you are an employee or you operate your own business. Personal expenses are not deductible―unless, of course, there is a specific provision in the tax code, such as the provisions for itemized deductions reported on an individual income tax return. The difficulty for many taxpayers, including Nicolas Cage and his advisors, comes in distinguishing between personal and business.

The General Rule for Business Expenses
For federal income tax purposes, you are allowed to deduct the ordinary and necessary expenses (but not capital expenditures) that you incur during the year in carrying on your trade or business. This general rule applies to individuals, partnerships, corporations, trusts, and estates.

  Ordinary and necessary―The IRS evaluates "ordinary and necessary" based on the specific facts and circumstances of each case. Ordinary expenses are those "common and accepted in your trade, business, or profession." Necessary expenses are "appropriate and helpful to your business. An expense does not have to be required to be considered necessary."

  Expenses―Expenditures that do not significantly add to the value of an asset, extend its useful life, or adapt it to a new use are expenses. An expenditure that does add value, extend life, or adapt use, is a capital expenditure. Rather than deducting the expenditure in the year incurred, you deduct it over the asset's life through depreciation, amortization, or depletion.  

  Trade or business―To establish the business relationship of the expenditures, they should be incurred with regard to an "activity carried on for a livelihood or for profit." In other words, there must be some form of economic activity conducted and a profit motive. 

At times, it may be necessary to allocate expenditures that relate to both personal and business use―for example, a car that is used for business travel during the workweek and for family trips on the weekends.

Eligible Deductions for Employees
As an employee, you can deduct reasonable work-related expenses as miscellaneous itemized deductions on your federal income tax return to the extent the expenses are not reimbursed by your employer. Not surprisingly, you must keep all receipts or other records necessary to support the business expenses that you deduct.

Typical expenses that you may be able to deduct include the following:

  Travel expenses―including food and lodging, entertainment, and gifts―when your work requires you to be away from your tax home for more than a day

  Local transportation that involves travel between workplaces (The cost of commuting from home to work is not deductible.)

  Dues to professional or business organizations and subscriptions to professional and trade publications

  Union dues and expenses

  Uniforms or other work clothes that are required for work and are not suitable for other wear

  Work-related educational expenses

  Tools and any supplies necessary for your work

  Job-related legal fees

  Job search expenses, if the job search is related to your current occupation

  Home office expenses if the space is used regularly and exclusively for work

If you are reimbursed by your employer or given an advance to cover your business expenses, you may have to report the payments from your employer as income and separately deduct the expenses on your tax return. However, if your employer's reimbursement policy requires all of the following, you do not have to report the income and deductions on your tax return:   

  The expenses for which you request reimbursement must be deductible and have been incurred while you were performing services as an employee.

  You must adequately account for such expenses within a reasonable period of time. 

  Any excess reimbursements or advances must be returned within a reasonable period of time.

Eligible Deductions for Businesses
Businesses―whether sole proprietorships, partnerships, or corporations―can deduct the ordinary and necessary expenses required to conduct their operations.

Nicolas Cage's business, and many others, run into trouble with the IRS if they deduct expenses that are not considered to be ordinary and necessary for the industry in which they operate. They are also subject to IRS challenge if they appear to deduct expenditures that might be considered payments for the personal expenses of owners, partners, shareholders, or employees―or their family members. For example, reasonable travel costs for attending an important business conference in Orlando are deductible as business expenses, but the related travel costs for a spouse and child who plan to visit Disney World during the conference are not.

Payments made by a business to cover personal expenses should generally be deducted as compensation by the business, and recognized as income by the person on whose behalf they were paid―in this case, Nicolas Cage. 

Andrea Bonaccorsi is a CPA and a manager in the Bader Martin tax practice. She provides a blend of tax and business consulting services for closely held and family-owned companies, as well as high net worth individuals and families. Andrea serves clients in a range of industries, with an emphasis in real estate, professional services, and technology.

Save article

Email Bader Martin

Email to a Friend