What Cannot Be Written Off as a Business Expense?

The Internal Revenue Service (IRS) generally allows deductions for expenses that are considered “ordinary and necessary” in carrying on a trade or business. An “ordinary” expense is one that is common and accepted in your industry, while a “necessary” expense is helpful and appropriate for your business, even if not indispensable.

However, not all money spent by a business qualifies for a tax deduction. Certain expenditures do not meet IRS criteria or are specifically disallowed by tax law. Properly identifying these non-deductible outlays is important for accurate tax reporting and avoiding potential issues like audits and penalties.

Expenses That Are Primarily Personal

Expenses that predominantly serve a personal benefit rather than a direct business purpose are generally not deductible. The IRS maintains a clear distinction between personal living expenses and legitimate business costs. This separation is rooted in the principle that only expenditures incurred for profit-seeking activities are eligible for tax reduction.

The cost of traveling from one’s home to a regular place of business, commonly known as commuting, is considered a personal expense. The IRS views the choice of where one lives relative to their workplace as a personal decision, not a business one.

Similarly, personal meals and entertainment are typically not deductible. While specific rules exist for business meals, such as those during business travel or with clients where a business discussion takes place, general meals consumed during the workday are personal. These include a quick lunch taken alone or dinner with family, even if a business owner works extended hours.

Clothing suitable for general wear, like a suit or dress, is not deductible, even if worn for work purposes. The deduction is limited to specific uniforms or protective gear not adaptable to everyday use and required for the business. Expenses related to personal grooming and hygiene, such as haircuts or toiletries, are also considered personal living expenses and are not deductible.

In situations where an expense has both business and personal components, such as a home office or a vehicle used for both personal and business travel, only the portion directly attributable to business use may be deductible. For example, if a vehicle is driven 60% for business and 40% for personal use, only 60% of the associated operating expenses, like fuel and maintenance, may be considered for deduction.

Costs Subject to Capitalization

Some expenditures, while related to a business’s operations, cannot be immediately deducted as expenses in the year they are incurred. Instead, these costs must be “capitalized,” meaning their value is recovered over time. This applies to assets with a useful life extending beyond the current tax year.

Capitalization defers the deduction of an expense, spreading it out over the asset’s useful life. This differs significantly from immediate expensing, which permits a full deduction in the year the expense is paid or incurred. This matches the expense of an asset with the income it helps generate over its operational life.

For tangible assets, such as buildings, machinery, and vehicles, the cost is recovered through depreciation. Depreciation systematically allocates the cost of the asset over its useful life, allowing a portion of the cost to be deducted each year. Intangible assets, like patents, copyrights, and software development costs, are amortized. Amortization is similar to depreciation but applies to intangible assets, spreading their cost over their legal or economic life. Natural resources, such as timber or mineral deposits, are subject to depletion, which allows for a deduction as the resource is extracted or consumed.

Common examples of capitalized assets include real estate like office buildings or factories, equipment ranging from computers to heavy machinery, and office furniture. Intellectual property, such as the cost to acquire or develop patents, trademarks, or software, also falls under capitalization. While the initial outlay for these items is not an immediate expense, the business recovers their cost through annual deductions over many years.

Specific Non-Deductible Business Related Outlays

Beyond personal expenses and capitalized assets, various specific business-related outlays are expressly prohibited from deduction by tax law, often for public policy reasons. These disallowances are distinct and apply even if the expense appears to be directly connected to business operations.

Fines and penalties paid to a government for violating a law are generally not deductible. This includes common infractions like traffic tickets, penalties for late tax filings, or environmental fines. Internal Revenue Code Section 162 specifically disallows such deductions, reinforcing the policy that taxpayers should not benefit from illegal activities through tax breaks.

Payments that constitute illegal bribes, kickbacks, or other illegal payments are also explicitly non-deductible. This rule applies whether the payment violates federal or state law, provided the state law is generally enforced and subjects the payor to criminal penalties or loss of a business license. Such disallowances prevent the tax system from subsidizing unlawful conduct.

Lobbying expenses incurred to influence legislation or participate in political campaigns are generally not deductible. This includes attempts to influence federal or state legislation, direct communications with certain executive branch officials, or efforts to influence the general public on political matters. Direct contributions to political parties or candidates are also not deductible business expenses.

The Tax Cuts and Jobs Act (TCJA) of 2017 eliminated the deduction for most entertainment expenses. Costs for activities like tickets to sporting events, concerts, golf outings, or membership dues for social, athletic, or sporting clubs are generally no longer deductible. However, business meals may still be 50% deductible if they are not lavish, involve the taxpayer or an employee, and are provided to a current or prospective business associate.

Even if an expense is business-related, it must be “reasonable” in amount to be deductible. For instance, while business travel is deductible, the cost of a first-class flight might be questioned if a more economical option was readily available. Business gifts are subject to a strict annual limit; a taxpayer can deduct no more than $25 per recipient per year, as outlined in Internal Revenue Code Section 274. This limit applies to the total value of gifts given to any single individual within a tax year.

Activities Lacking a Profit Motive

If an activity is not carried on with the genuine intention of making a profit, it may be classified as a hobby rather than a business for tax purposes. This “hobby loss” rule prevents individuals from deducting losses from recreational or personal pursuits against other sources of income, such as wages or investment earnings. The IRS expects a business to have a legitimate profit motive.

The IRS considers several factors when determining if an activity is a hobby or a business. These include how the taxpayer conducts the activity, such as maintaining accurate books and records, and the expertise of the taxpayer or their advisors in the field. The time and effort dedicated to the activity, along with any expectation that assets used in the activity might appreciate in value, are also considered.

Other factors include the taxpayer’s success in similar activities, the history of income or losses from the activity, and the amount of occasional profits earned. The financial status of the taxpayer and the presence of elements of personal pleasure or recreation in the activity also play a role in the IRS’s determination. If an activity is consistently unprofitable, especially after a startup phase, it raises questions about a profit motive.

While income generated from a hobby must be reported on a tax return, the expenses related to that hobby are generally not deductible against other income. Under current law, hobby expenses are largely non-deductible, except to the extent they offset hobby income. This distinction is particularly relevant for individuals who pursue side gigs or passion projects that may not yet be consistently profitable.