Publication 535 Business Expenses: What You Need to Know for Your Business

Running a business comes with many costs, but not all can be deducted from taxable income. The IRS provides guidelines on deductible expenses to help businesses reduce their tax burden legally and efficiently. Understanding these rules is crucial to avoid mistakes that could lead to penalties or missed savings.

Publication 535 outlines deductible business expenses and clarifies distinctions between different types of costs. Properly categorizing and tracking expenses ensures compliance and maximizes potential deductions.

Types of Deductible Expenses

Only expenses that are both ordinary (common in the industry) and necessary (helpful and appropriate for the business) qualify as deductible. Identifying these correctly lowers taxable income and improves cash flow.

Advertising and Marketing

Promotional costs are fully deductible if they directly relate to attracting or retaining customers. This includes digital and print advertisements, website development, social media campaigns, business cards, and sponsorships. Hiring a marketing consultant or hosting a promotional event also qualifies.

However, lobbying costs, political contributions, and payments to influence legislation are not deductible. Goodwill advertising, such as sponsoring a charity event, must have a clear business purpose. For example, donating to a nonprofit in exchange for placing the company’s logo in event materials would likely qualify, whereas a general donation without promotional benefits would not. Businesses should keep invoices, contracts, and receipts to substantiate marketing deductions.

Insurance

Premiums for business-related insurance policies are deductible if they protect the company’s operations, employees, or assets. Common deductible policies include general liability, property insurance, workers’ compensation, and professional malpractice coverage. Health insurance premiums for employees are also deductible, and self-employed individuals may qualify to deduct their own health insurance costs, subject to IRS rules.

However, life insurance premiums for owners or employees are not deductible if the business is the policy beneficiary. Insurance that covers loan repayments is also generally not deductible. Businesses should review IRS guidelines to ensure policies are correctly classified and maintain records of payments and policy terms to support deductions.

Home Office

Business owners who work from home may deduct a portion of household expenses if a specific area of the residence is used exclusively for work. This space must serve as the principal place of business or a dedicated site for meeting clients or customers. Deductible costs include a percentage of rent or mortgage interest, property taxes, utilities, and maintenance expenses.

There are two ways to calculate the deduction:

– Simplified method: A flat $5 per square foot, up to 300 square feet.
– Regular method: Determines the percentage of the home used for business and applies that percentage to eligible expenses.

The regular method often results in a larger deduction but requires detailed recordkeeping. Since home office deductions are frequently scrutinized by the IRS, maintaining documentation such as utility bills, lease agreements, and photographs of the workspace can help substantiate claims in case of an audit.

Capital vs. Current Expenditures

The IRS distinguishes between costs that provide immediate benefits and those that offer long-term value.

– Current expenditures: Fully deductible in the year they are incurred. These cover short-term operational needs, such as office supplies, employee wages, and routine maintenance.
– Capital expenditures: Costs related to acquiring or improving assets that provide value beyond the current tax year. These include equipment, vehicles, buildings, and major property upgrades. Instead of deducting them in full, businesses must capitalize and depreciate or amortize them over time.

For example, a $50,000 machine must be depreciated over multiple years based on its IRS-assigned recovery period.

Repairs and maintenance can be tricky. Routine fixes, such as repainting an office or replacing a broken window, are deductible as current expenses. However, improvements that enhance an asset’s value, extend its life, or adapt it for a new use—such as installing a new HVAC system—must be capitalized. The IRS provides guidance under the Tangible Property Regulations to help businesses determine whether a cost qualifies as an improvement or a repair.

Depreciation rules further impact how businesses account for capital expenditures. The Modified Accelerated Cost Recovery System (MACRS) is the primary method for depreciating tangible assets, assigning different recovery periods based on asset type. For example:

– Office furniture: 7-year depreciation schedule
– Commercial buildings: 39-year depreciation schedule

Some businesses qualify for accelerated depreciation methods, such as Section 179 expensing or bonus depreciation, which allow for larger upfront deductions. In 2024, the Section 179 deduction limit is $1.22 million, with a phase-out threshold of $3.05 million, enabling businesses to immediately expense qualifying purchases instead of spreading deductions over time.

Handling Personal vs. Business Costs

Keeping personal and business finances separate is essential for tax compliance. Only expenses directly related to generating business income can be deducted. Mixing personal and business funds can lead to disallowed deductions, increased audit risk, and potential legal consequences.

A common issue arises with travel and entertainment expenses. A business trip that includes personal activities must be carefully allocated, as only the work-related portion is deductible. For example, if a business owner attends a conference in another state but stays additional days for vacation, only expenses incurred during the official event qualify. Similarly, taking a client to dinner for a business discussion allows for a 50% deduction on the meal, but if family members are present, their portion is not deductible. The IRS closely examines these expenses, especially when they involve luxury accommodations or high-end dining, so businesses should maintain clear documentation.

Vehicle use also requires careful tracking. A car used for both business and personal purposes must have mileage recorded to determine the deductible portion. The IRS allows two methods:

– Standard mileage rate: 67 cents per mile in 2024.
– Actual expense method: Accounts for fuel, maintenance, insurance, and depreciation based on the percentage of business use.

If a vehicle is primarily personal but occasionally used for work, deductions should reflect only the miles driven for business-related activities.

Recordkeeping Essentials

Accurate financial records are necessary for substantiating deductions, preparing tax returns, and ensuring compliance with IRS regulations. The IRS requires documentation to establish the amount, purpose, and legitimacy of each expense. Supporting documents include receipts, invoices, canceled checks, and bank statements. Digital bookkeeping solutions such as QuickBooks, Xero, and Wave help streamline record management, but businesses must ensure electronic copies meet IRS standards for readability and accessibility.

The length of time records should be kept depends on the type of document and the statute of limitations for tax assessments:

– Income tax records: At least three years from the filing date.
– Substantial underreporting of income (more than 25%): IRS can audit up to six years back.
– Payroll tax records (W-2s, 1099s, etc.): At least four years after the due date of the tax or the date it was paid, whichever is later.
– Depreciation schedules, loan agreements, and capital improvement records: Should be kept indefinitely to track basis adjustments and potential gains or losses upon asset disposal.

Proper recordkeeping safeguards a business in the event of an audit and provides a clear financial picture for decision-making.