Business, partnership, and corporate tax deductions are permitted if they are considered “ordinary and necessary.” In order for an expense to be considered a business tax deduction, it must be appropriate, helpful, and reasonable to the business — even if not absolutely essential or the only means to achieve a result. A corporate deductible expense must be of the type that commonly or frequently occurs in the type of business involved. These rules are quite broad, and there is extensive case law and IRS guidance on what is permissible and what is not. This article discusses the largest and most common business tax deductions that we see on corporate and partnership tax returns.
The ability to deduct the cost of goods sold (COGS) derives from the U.S. Constitution. Because of this, it is the one business tax deduction that must be provided to taxpayers and cannot be curtailed by the IRS. It is important to remember, though, that COGS is not the cost of selling goods; rather, it is the cost of goods that have already been sold. There are complex rules governing what is and what is not included in the calculation of COGS, and those rules are beyond the scope of this article, but we do want to highlight that many of the deduction items discussed in this article can be includible in COGS under certain circumstances. If that is the case, then the timing of the deduction would be affected but not the amount to be deducted.
Clients often ask, are business expenses tax deductible? If they’re referring to operating expenses, the answer is yes. Business tax deductions for operating expenses include things like rent, payroll, and office expenses/supplies. These deductions are fairly straightforward to understand even if the details surrounding the tax deduction can sometimes get complicated. For example, payroll expenses include salary, pension, and profit-sharing plans, healthcare expenses, bonuses, awards, sick pay, vacation pay, and tuition reimbursement. There are myriad ways that businesses can compensate their employees, and we cannot list them all here, but keep in mind that certain expenses can be structured in a tax-favorable manner so that the business obtains a deduction and the employee does not have to include any amount in income. Some examples of this include traditional birthday or holiday gifts of property (not cash) with a low fair market value (e.g., turkeys, hams, and other merchandise of nominal value given at holidays), coffee, doughnuts, and soft drinks, and occasional cocktail parties, group meals, or picnics for employees and their guests.
Other effective business tax deductions include payments for equipment, taxes, interest, insurance, travel, meals, advertising, professional services (legal and accounting fees), consulting, and bad debts.
The deduction for equipment usually comes in the form of depreciation over the useful life of the property. In certain cases, businesses also can take advantage of 100% bonus depreciation, which was expanded recently, and section 179 expensing up to certain limits ($1.02M in 2019 subject to a phase-out).
Taxes are another common deduction to be aware of during business tax preparation. These business tax deductions include payments for real estate taxes, the employer’s portion of federal payroll taxes, state income, and franchise taxes, and various types of sales/excise/fuel/license taxes. The one tax that is not deductible is a corporation’s payment of its own federal income taxes. Also, no deduction is allowed for the payment of state or local tax assessments that relate to improvements on the entity’s property, e.g., assessments for sidewalk repairs, water/sewer lines, etc.
Another common question is whether business loans are tax-deductible? The principal payment at maturity is not, but interest payments on business loans are deductible, including actual payments of interest (in cash or property) as well as interest paid in the form of original issue discount. Section 163(j) provides an interest deduction limitation of 30% of a business’s adjusted taxable income, which is scheduled to change in 2023, but certain businesses (such as real estate) can elect out of section 163(j) by agreeing to slow the timing of certain other deductions. Section 163(j) is complex and beyond the scope of this article, but for those readers that are familiar with it, final regulations are expected in the next few months and hopefully, they will provide clarity beyond the proposed regulations that were issued in December 2018.
Insurance premiums are tax-deductible. Typically we see deductions for insurance on items like directors and officers liability, workers’ compensation, employment practices liability, fire, theft, automobile and umbrella insurance policies. Newer forms of insurance keep arising, such as insurance relating to employee misconduct, and payments for these newer forms of insurance are deductible too.
Expenses for business travel are deductible. This includes the cost of buses, trains, planes, and automobiles, including taxis, car services, Uber, and Lyft. Travel expenses also include the cost of business meals while traveling.
Business meals are 50% deductible provided they are not lavish or extravagant and an employee of the business is present when the meal is furnished. There is a 100% deduction for the cost of nominal food and beverage items provided to employees (e.g., bagels, coffee, etc.), as well as the cost of food provided at holiday parties. Even though expenses for entertainment, amusement, and recreation generally are no longer deductible, meals provided during such events are 50% deductible if the taxpayer can prove it was business-related.
The cost of advertising is tax-deductible, including the cost of promotional materials, advertising at conferences, website ads, yellow page ads, business cards, etc.
Fees paid to legal, tax, accounting, and financial advisors generally are fully deductible. This includes the cost of tax return preparation and business litigation expenses.
Businesses commonly extend credit to customers and sometimes these extensions of credit become uncollectible. Accrual method businesses that realize bad debts during a tax year can deduct the bad debt to the extent it becomes worthless. There are rule that permit deductions for partially worthless debts, and rules governing the deduction for wholly worthless debts. These rules generally require the worthlessness to be evidenced by a fixed and identifiable event during the tax year, and a charge-off in the case of partially worthless debts. A charge off is accomplished by removing the debt from the entity’s balance sheet.
Finally, we would be remiss if we did not mention the deduction for qualified business income (QBI) even though technically it is not a deduction at the business level. This deduction, now in its second year, applies to income received from partnerships, S corporations, and sole proprietorships, but it does not apply to C corporations or to dividends received from C corporations. The rules relating to the deduction for QBI are complex, but in general, the deduction equals 20% of the individual’s QBI subject to certain wage and property limits after a threshold amount of QBI.
If you have any questions relating to your corporate tax deductions, partnership tax deductions, or qualified business income, contact a Withum business tax advisor online for advice tailored to your organization’s particular situation.