What Are Allowable Expenses?

Allowable expenses are costs a business or self-employed individual incurs directly related to earning income. These expenses are subtracted from revenue, reducing taxable profit and the amount of tax owed. They represent the necessary outlays for operating a trade or business. Understanding these deductions helps optimize a business’s financial position by lowering its tax liability.

Criteria for Allowability

For an expense to be allowable, it must meet the “ordinary and necessary” criteria as defined by the Internal Revenue Service (IRS). An “ordinary” expense is common and accepted within a particular industry or type of business. It is typical for the business’s operations.

A “necessary” expense is considered helpful and appropriate for the business, even if not strictly indispensable. This means the expenditure aids in the development or continuation of the business. For instance, a business lunch with a client directly related to business discussions could be considered necessary, whereas a personal dinner would not.

The core principle is that the expense must be incurred “wholly and exclusively” for business purposes. This rule implies that if an expense has a dual purpose—partly business and partly personal—it generally cannot be fully deducted unless the business portion can be clearly identified and separated. For example, using a personal vehicle for business travel allows only the business-use portion of expenses to be deducted.

Common Categories of Allowable Expenses

Many types of expenditures commonly incurred by businesses can be allowable if they meet the “ordinary and necessary” criteria. Office expenses frequently qualify, including rent for business premises, utility fees such as electricity and internet, and the cost of office supplies like stationery and printing ink. Software subscriptions and general office maintenance and repair costs are also typically deductible.

Travel expenses are a significant category for businesses requiring movement away from their tax home. This includes costs for transportation like airfare, train tickets, bus fares, and car rentals. Lodging expenses, such as hotel stays, are deductible when away from home overnight for business. While meals incurred during business travel are generally 50% deductible, incidentals like dry cleaning, laundry, and tips related to travel can also be included.

Marketing and advertising expenses are generally fully deductible as they are considered ordinary and necessary for promoting and growing a business. This category encompasses a wide range of costs, including print advertisements, digital advertising campaigns on platforms like Google or social media, and website development and maintenance fees. Promotional materials such as business cards, brochures, and branded merchandise also fall under this umbrella.

Professional fees, such as those paid to accountants, lawyers, and consultants, are typically allowable. These are costs associated with obtaining expert advice or services essential for business operations. Vehicle expenses for business use, including fuel, oil, repairs, insurance, and registration fees, are also deductible. Businesses can choose between deducting actual expenses or using the standard mileage rate, along with business-related parking fees and tolls.

Employee compensation, including salaries, wages, bonuses, and benefits like health insurance and retirement contributions, are allowable expenses. Insurance premiums for various business coverages, such as liability insurance, property and casualty insurance, and workers’ compensation, are also deductible. Continuing education and training costs for employees that maintain or improve skills required for the business are typically allowable.

Expenses Not Typically Allowable

Certain expenses, even if seemingly related to business, are generally not deductible. Purely personal expenses, which are not directly tied to business operations, cannot be written off. This includes daily commuting costs between a home and a regular workplace, as these are considered personal rather than business travel. Personal groceries or personal vacations, for instance, are clear examples of non-deductible personal expenses.

Capital expenditures, which are costs for assets that have a long-term value and benefit the business for more than one year, are not immediately deductible in full. Instead, their cost is typically recovered over time through depreciation, amortization, or Section 179 deductions. Examples include large equipment purchases, buildings, or significant website development costs that create a long-term asset.

Entertainment expenses, such as tickets to sporting events, concerts, or club memberships, are generally not deductible after changes introduced by the Tax Cuts and Jobs Act of 2017. While certain meals remain partially deductible, the cost of entertainment itself, even if for business purposes, is largely disallowed. However, there are exceptions, such as recreational activities primarily for the benefit of employees, like company picnics or holiday parties.

Fines and penalties imposed by government agencies, such as parking tickets or regulatory fines, are also not deductible. These are considered consequences of non-compliance rather than ordinary and necessary business expenses. Similarly, political contributions and lobbying expenses are typically non-deductible.

Record Keeping for Expenses

Accurate and organized record-keeping is crucial for substantiating all business expenses. Businesses must maintain records to support the amount, time, place, and business purpose of each expense. This documentation is essential for tax purposes, particularly if the business faces an audit.

Key types of records to retain include receipts, invoices, canceled checks, and bank statements. For vehicle expenses, a detailed mileage log documenting business travel is important. Digital record-keeping is widely accepted and often more manageable than paper records, provided the digitized copies are clear and a reliable backup system is in place.

The IRS generally recommends retaining tax documents for at least three years from the filing date of the return. Some records, like business formation documents, should be retained indefinitely.