What in Your Annual Operating Plan Is Tax Deductible?

An Annual Operating Plan (AOP) details a business’s financial and operational objectives and the resources needed to achieve them over a typical one-year period. Businesses often seek to understand which expenses incurred in pursuit of their AOP goals are eligible for tax deductions.

General Principles of Business Deductions

The Internal Revenue Service (IRS) establishes criteria for determining whether a business expense is deductible. Internal Revenue Code Section 162 states an expense must be “ordinary” and “necessary.” An ordinary expense is one that is common and accepted within a particular industry or type of business. A necessary expense is helpful and appropriate for the business, though it does not need to be indispensable.

Expenses that are lavish or extravagant are not deductible, even if they meet the ordinary and necessary criteria. Businesses must also distinguish between current and capital expenses. Current expenses are day-to-day costs fully deductible in the tax year they are incurred, such as rent or utility bills.

Capital expenses are investments in assets with a useful life extending beyond one year, like equipment or real estate. These costs cannot be fully deducted in the year of purchase; instead, they must be capitalized and recovered over multiple years through depreciation or amortization. This distinction is important as it impacts the timing and method of claiming deductions related to AOP expenditures.

Common Deductible AOP Expenses

Many common expenses outlined in an Annual Operating Plan are tax-deductible when they adhere to the “ordinary and necessary” principles. Marketing and advertising costs, for instance, are deductible as they are considered necessary for attracting and retaining customers. This includes expenditures for digital advertisements, print campaigns, promotional events, website development, and public relations activities.

Salaries and wages paid to employees are fully deductible as long as the compensation is reasonable and for services rendered to the business. This includes regular pay, bonuses, commissions, and paid time off related to AOP objectives. Research and Development (R&D) expenses have specific tax treatment. These costs, including software development, must be capitalized and amortized over five years for domestic research and 15 years for foreign research.

Office supplies and minor equipment are deductible as routine operational costs. Larger equipment purchases are capitalized and depreciated over their useful life.

Business travel expenses, including airfare, lodging, and 50% of meal costs, are deductible when employees are away from their tax home for business purposes related to AOP goals. Professional fees paid to accountants, lawyers, or consultants for services beneficial to the business are deductible. These services, such as tax preparation, legal advice, or strategic consulting, are considered necessary for business operations and compliance. Rent and utility payments for business premises are direct costs and are fully deductible.

Substantiating and Reporting AOP Deductions

Maintaining accurate records is important for substantiating any business deductions claimed on a tax return. Businesses should keep accurate documentation for all expenses, including invoices, receipts, bank statements, canceled checks, credit card statements, and payroll records. For certain expenses like travel, specific logs detailing the business purpose are important. These records provide proof of the expense and its direct relation to business activities.

The IRS requires businesses to retain these records for three years from the date the tax return was filed or the due date of the return, whichever is later. It is advisable to keep records longer, up to six or seven years, to cover extended audit periods. Once expenses are documented, they must be reported on the appropriate tax forms. Sole proprietors and single-member LLCs report their business income and expenses on Schedule C (Form 1040). Partnerships and multi-member LLCs use Form 1065, while corporations file Form 1120 for C corporations or Form 1120-S for S corporations.