8737 / What is a business expense deduction?

A business expense deduction is a deduction allowed for ordinary and necessary expenses paid or incurred in connection with an individual’s trade, business or profession.1 The deduction allowed under IRC Section 62(a)(1) for expenses of a trade or business is the provision which technically allows for business income to be taxed on a net income basis, whether it be a corporate business or the business of individual taxpayers operating as sole proprietors or partners. In the case of a sole proprietorship or partnership, IRC Section 62(a)(1) operates to assure that all trade or business expenses, deductible as delineated under specific IRC Sections, are effectively allowed as above-the-line deductions, rather than itemized deductions. In the case of a sole proprietor, all but a few of these expenses are deducted in Schedule C of Form 1040.

For purposes of determining whether an expense may be deducted as a business expense, an expense is considered to be “ordinary” if it is one that is commonly incurred in the trade or occupation of the taxpayer. An expense is “necessary” if it is found to be appropriate or helpful to the taxpayer’s business or occupation. Among the common expenses in this category are: employees’ salaries; office rent; interest on business loans; the cost of supplies and utilities; traveling; entertainment; advertising; and automobile expenses. Note that the deduction for most forms of business entertainment, with the exception of meals, was suspended for 2018-2025.

Generally, business expenses of a self-employed individual (sole proprietor, independent contractor, or professional) may be deducted from gross income to arrive at adjusted gross income. The deductions are taken on Schedule C of Form 1040 in computing the net gain or loss from the taxpayer’s business or profession.

The IRS has ruled that a full-time life insurance salesperson who is treated as a “statutory employee” for FICA purposes is not an “employee” for purposes of IRC Sections 62 and 67. Such individuals may thus treat unreimbursed business expenses as “above the line” deductions. This ruling was issued in part to clarify that taxpayers who are treated as “statutory employees” for FICA purposes (as are life insurance salespersons) are not necessarily treated as “employees” for other purposes.² The term “statutory employee” refers to certain individuals described in IRC Section 3121(d)(3)(B), who are subject to FICA withholding requirements (see Q 8722). The ruling’s effect was essentially limited to those individuals.

---

Planning Point: Although many employers have required employees to return to offices, others are permitting employees to continue working remotely. It’s important to remember that common law employees are not entitled to deduct business expenses in the same manner as self-employed taxpayers.

In some jurisdictions (California and Illinois, for example) employers are required to reimburse employees for employment expenses. This may create the need for employers to reimburse employees for the cost of maintaining a home office. Further, the Fair Labor Standards Act (FLSA) does not permit an employer to require an employee to pay for business expenses if doing so would reduce the employee’s earnings to below the minimum wage. However, simply providing cash reimbursement may generate additional taxable income for the employee. The miscellaneous itemized deduction for expenses incurred in the “trade or business of being an employee” was suspended for 2018-2025. Employers may instead wish to consider a program where the employer leases or purchases the required equipment for the employee’s use.

---

See Q 8738 to Q 8753 for a detailed discussion of the various types of business expenses commonly deducted by taxpayers.