Do you spend money on your business throughout the year? If you’re a business owner, I’m sure you do. While some of those costs can be deducted from your tax return, not all business expenses qualify. Learn what types of costs you can deduct, as well as what it means to overstate your business expenses – and what penalties you might face from the IRS if you do.
Key Insights We Will Discuss
- What counts as a business expense
- Separating your expenses
- Types of expenses you can deduct on your tax return
- What is means to overstate your business expenses
- Penalties for making false deductions on your returns
What Counts as a Business Expense?
According to the IRS, a business expense must be both ordinary and necessary to be deductible. What does that mean?
An Ordinary Business Expense is one that is common and accepted in your trade or business.
A Necessary Business Expense is one that is helpful and appropriate for your trade or business.
However, there is a catch. Even though an expense is considered ordinary and necessary, you may not be able to deduct it for that tax year. What’s more, an expense may not be deductible at all.
Your next question may be “How am I supposed to know whether or not I can deduct an expense?” Well lucky for you, the answer is relatively simple. In what follows we’ll break it down for you.
Separating Your Business Expenses
The best way to tell the difference between an expense you can deduct and an expense that you can’t deduct, is by keeping your expenses separated from the following items.
Costs of Goods Sold
If you’re in the business of manufacturing products or purchasing products for resale, you will generally have to value your inventory at the beginning and end of every tax year to determine the cost of goods sold. Then the cost of goods sold is deducted from your gross receipts to determine your annual profits for that year.
Expenses That Fall Under the Cost of Goods Sold
- Cost of products or raw materials, including freight.
- Direct Labor
- Factory Overhead
There are some costs that must be capitalized, rather than deducted. Those costs are called Capital Expenses, and they are generally considered to be assets and are part of your investment into your business.
There are three types of costs that typically fall under this category. They are:
- Business start-up costs
- When you go into business, treat all costs you had to get your business up and running as capital expenses.
- Business assets
Although you may not be able to take a current deduction on the above costs, you may be able to recover them through depreciation, amortization, or depletion. The details on this are beyond the scope of this blog.
Personal, Living, or Family Expenses
By rule of thumb, the IRS says you cannot deduct personal, living, or family expenses on your tax return. However, there is an exception if you incur a cost from something that is used partly for business and partly for personal reasons. In these cases, you can divide the total cost between business and personal expenses and deduct the business portion.
Business Expenses You Can Deduct
Business Use of Your Home
If you use part of your home for your business, you might be able to deduct certain expenses. To qualify, you must use part of your home:
- Exclusively and regularly as your principal place of business
- Exclusively and regularly as a place where you meet or deal with patients, clients, or customers in the normal course of your business activities
- If you use a separate structure that is not attached to your home, it must be used exclusively and regularly for your business.
- On a regular basis for storage use
- For rental use
- As a day care facility (specific rules for this are beyond the scope of this blog)
Business Use of Your Car
You can deduct car expenses if you use your car for your business. If you use your vehicle for both personal and business, then you must divide your expenses based on mileage. To see the most current mileage rates, click here.
Paying Your Employees
You can typically deduct the wages you pay your employees.
If you rent a property for your business, you can deduct the cost.
You can deduct various federal, state, local and foreign taxes attributed to your business.
You can deduct the cost of insurance if it is for your business or profession.
What Does it Mean to Overstate my Business Expenses to the IRS?
Overstating your business expenses is essentially reporting inaccurate figures and stating those inaccurate figures on your tax returns. If you make false business deductions on your tax return – or if you enhanced the amount of money you deducted for an expense – this can be considered overstating your business expenses.
However, it isn’t all falsifying or enhancing numbers. For example, you could find yourself in this situation if you take a guess on an expense amount because you lost some receipts or threw one away by mistake.
One way or the other, you can face some harsh penalties for overstating your business expenses and making false deductions, which amounts to filing an incorrect return. Your return could also be selected for audit.
IRS Penalties for Making False Deductions
While enhancing a deduction on your tax return or fudging a couple of numbers might not seem like a big deal, the IRS can consider it to be a fraudulent return. This can result in criminal or civil penalties.
- You can be charged up to twenty percent of the disallowed amount for filing an erroneous claim for a refund or credit.
- A $5,000 penalty if the IRS determines you filed a return that does not include enough information to calculate the correct tax, or that contains data showing that the tax reported is incorrect.
- In addition to the full amount of tax owed, you could face a penalty of 75 percent of the amount owed if the underpayment on the tax return resulted from tax fraud.
Contact an Experienced Tax Attorney
If you overstated your business expenses on your tax return and are now facing penalties from the IRS, call Ayar Law at 800-571-7175 to receive free, no-obligation tax advice from a tax attorney.