Corporate Tax Deductions: What Businesses Can Claim and How to Report Them
Learn how businesses can identify eligible tax deductions, properly document expenses, and accurately report them to optimize their financial reporting.
Businesses constantly seek ways to lower their tax obligations legally, and claiming deductions for eligible expenses is a primary method. These deductions reduce a company’s taxable income, directly affecting its tax bill and available cash.
However, navigating the rules around deductions requires care. Not every expense qualifies, and errors in reporting can attract IRS scrutiny or penalties. Understanding which costs are deductible, how to document them properly, and where to report them is essential for maximizing savings while remaining compliant.
Basic Eligibility for Deductions
For a business expense to be deductible, it must be directly related to the company’s efforts to generate income. The Internal Revenue Code Section 162 establishes that expenses paid or incurred during the tax year for carrying on a trade or business are generally deductible if they meet two key standards: they must be both “ordinary” and “necessary.”1Legal Information Institute. 26 U.S. Code § 162 – Trade or Business Expenses
An ordinary expense is one that is common and accepted within the business’s specific industry or field. It doesn’t have to occur frequently, but it must be a recognized type of cost for that line of work. A necessary expense is one that is helpful and appropriate for the business, even if not absolutely indispensable.2Internal Revenue Service. Ordinary and Necessary Expenses It should contribute to the company’s operations or revenue generation.
Beyond being ordinary and necessary, the expense amount must be reasonable. Lavish or extravagant costs, particularly for items like meals or travel, might be limited or disallowed. Expenses must typically be paid or incurred within the tax year claimed. Costs that are personal in nature, or expenditures for assets providing long-term benefits (capital expenditures), are generally not deductible as current business expenses, although capital costs may be recovered over time through depreciation. Expenses used in calculating the Cost of Goods Sold cannot be deducted again elsewhere.3Internal Revenue Service. Publication 535, Business Expenses (2022)
Common Deductible Expense Categories
Businesses incur various costs that often fall into deductible categories, provided they meet the basic eligibility criteria. Common areas include everyday operating costs, charitable giving, and the recovery of costs for long-term assets.
Operating Costs
Operating costs cover the day-to-day expenses required to run a business, separate from the costs of producing goods or acquiring major assets. Examples include:
- Rent or lease payments for facilities
- Utilities like electricity and water
- Salaries, wages, and associated employer payroll taxes
- Office supplies
- Professional fees for services like legal or accounting
- Business insurance premiums
- Advertising and marketing expenses
These costs are typically deductible in the year they are paid or incurred, depending on the company’s accounting method.
Charitable Contributions
Corporations can deduct qualifying charitable contributions made to organizations recognized by the IRS, often those designated under Section 501(c)(3). The annual deduction is generally limited to 10 percent of the corporation’s taxable income, calculated before considering the contribution itself and certain other items.
Contributions exceeding the annual limit can usually be carried forward and deducted over the next five tax years, subject to the same 10 percent limit in those years. Specific valuation rules apply to donations of property rather than cash.
Depreciation
When businesses purchase assets expected to last longer than one year—such as buildings, machinery, vehicles, or furniture—they generally recover the cost over time through depreciation, rather than deducting the full price upfront. Depreciation allocates the asset’s cost over its estimated useful life, accounting for wear and tear or obsolescence.
The primary method for calculating tax depreciation is the Modified Accelerated Cost Recovery System (MACRS), detailed in Section 168. MACRS assigns assets to classes with specific recovery periods (e.g., office furniture typically has a 7-year recovery period). Additionally, Section 179 allows businesses to potentially deduct the full cost of certain qualifying assets in the year they are placed in service, up to annual dollar limits.
Reporting Deductions on Business Returns
Accurately reporting deductions requires using the correct tax form based on the business structure. C corporations file Form 1120, where deductions are subtracted from income to determine corporate tax liability.
Other structures use different forms. S corporations file Form 1120-S, and partnerships use Form 1065. These are generally pass-through entities, meaning the business itself doesn’t pay federal income tax. Instead, income and deductions are calculated on the entity return, and each owner receives a Schedule K-1 detailing their share. Owners then report these items on their personal tax returns (Form 1040), often via Schedule E. Sole proprietors report business income and expenses directly on Schedule C of their Form 1040.
On each business return, deductions are typically itemized or aggregated in specific sections. For example, Form 1120 has a dedicated “Deductions” area. Businesses list eligible costs like salaries, rent, and interest on the appropriate lines. Some deductions, like depreciation, require supporting forms (e.g., Form 4562) attached to the main return.
The figures reported must align with the company’s accounting records. The business’s accounting method (cash or accrual) determines when expenses are recognized and can be claimed as deductions.
Documentation Requirements
Businesses must maintain thorough records to substantiate all claimed deductions.4Internal Revenue Service. Recordkeeping The taxpayer bears the burden of proving that expenses are legitimate and meet deductibility requirements.5Internal Revenue Service. Burden of Proof Without adequate proof, the IRS may disallow deductions.
While no single recordkeeping system is mandated, records must clearly show income and expenses. Common supporting documents include invoices, paid bills, sales slips, canceled checks, and bank or credit card statements.6Internal Revenue Service. What Kind of Records Should I Keep? These should verify the amount paid, the payee, the payment date, and the business nature of the expense.
Stricter substantiation rules under Section 274 apply to expenses for travel, meals, gifts, and the use of “listed property” like vehicles.7Legal Information Institute. 26 CFR § 1.274-5A – Substantiation Requirements For these, records must also show the time, place, business purpose, and business relationship of individuals involved. Generally, documentary evidence like a receipt is needed for lodging and any other expense of $75 or more.
Records should be kept as long as they might be needed for tax administration, typically three years from the date the return was filed or due, whichever is later. Longer periods apply in certain situations: at least four years for employment tax records, seven years for losses from worthless securities or bad debts, and potentially longer for property assets (until the disposal year’s limitation period expires). Records related to fraudulent returns or unfiled returns should be kept indefinitely.
The IRS accepts both paper and electronic records. Electronic systems, whether in-house or third-party, must ensure accuracy, preserve records securely, allow retrieval, and reproduce legible copies, according to guidance like Revenue Procedure 97-22.8Internal Revenue Service. Revenue Procedure 97-22 (Electronic Records) Regardless of format, records must be organized and accessible for potential IRS review.
Considering Net Operating Losses
A Net Operating Loss (NOL) occurs when a business’s allowable deductions exceed its gross income for the tax year. This often happens during startup phases or in cyclical industries. Section 172 allows businesses to use these losses to offset taxable income in other years, helping to average tax liability over time.9Legal Information Institute. 26 U.S. Code § 172 – Net Operating Loss Deduction
The rules for using NOLs have changed significantly. Historically, NOLs could often be carried back to offset prior-year income and carried forward. However, the Tax Cuts and Jobs Act of 2017 (TCJA) largely eliminated NOL carrybacks for losses arising in tax years starting after 2017 (with limited exceptions for farming and certain insurance companies). Instead, these NOLs can be carried forward indefinitely.
The TCJA also introduced a limit: the NOL deduction in a future year is generally capped at 80% of that year’s taxable income (calculated before the NOL deduction). This means a company might still owe some tax even with NOL carryforwards.10Internal Revenue Service. Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts
The CARES Act provided temporary relief during the pandemic, allowing a five-year carryback for NOLs from 2018, 2019, and 2020, and suspending the 80% limitation for tax years beginning before 2021.
After the CARES Act provisions expired, the rules generally reverted. NOLs arising in tax years starting after 2020 typically cannot be carried back (aside from the exceptions) but can be carried forward indefinitely, subject to the 80% taxable income limitation. NOLs generated before 2018 are generally not subject to the 80% limit and retain their original carryforward period (often 20 years). NOLs must typically be used chronologically against income in the earliest available year first.