What Is an Unusual Expense for Tax and Accounting?

An unusual expense is a cost a business incurs that falls outside its normal operational activities, such as inventory purchases or payroll. These expenses require specific treatment in financial reporting and for tax purposes because they can impact a company’s reported profitability. Identifying these costs allows for a clearer view of a company’s sustainable, core financial performance.

Characteristics of an Unusual Expense

An unusual expense has two main characteristics: it is not related to the principal operations of the business, and it occurs infrequently. The cost must arise from an event or transaction that is abnormal and only incidentally related to the company’s ordinary activities. For example, for a retail company, the costs of goods sold and marketing are part of its principal activities, not unusual expenses.

The second characteristic, infrequency of occurrence, means the underlying event is not reasonably expected to happen again in the foreseeable future. This assessment considers the company’s operating environment. A loss from a hurricane in a region where such storms are rare would be considered infrequent, but for a business in a hurricane-prone area, it might not be.

Common examples of unusual expenses include losses from a natural disaster like a fire or flood, costs related to a corporate restructuring, large settlements from lawsuits, or write-downs of assets like inventory or property. Gains can also be considered unusual, such as the profit from selling a segment of the business or a one-time gain from extinguishing debt early.

Previously, U.S. Generally Accepted Accounting Principles (GAAP) used the classification “extraordinary items” for events that were both unusual and infrequent. In 2015, the Financial Accounting Standards Board eliminated this category to simplify income statement presentation. Now, these events are reported as unusual or infrequent items, but not as extraordinary.

Presentation on Financial Statements

For financial reporting, a material event that is unusual or infrequent must be reported as a separate component of income from continuing operations. Under U.S. GAAP, this means it is listed as a distinct line item on the income statement before the calculation of income tax expense, as outlined in Accounting Standards Codification 225.

This separate presentation allows investors and analysts to see the impact of the non-recurring event. By isolating the unusual expense, a person can better evaluate the profitability of the company’s core business activities. This helps in forecasting future earnings, as the one-time expense can be excluded from projections.

The placement of the unusual expense on the income statement affects financial metrics. It may be classified as an operating or non-operating item, but its separate disclosure prevents it from being obscured within other general expense categories. This ensures it does not distort the perception of the company’s normal operational efficiency.

Companies are also required to provide details in the footnotes to the financial statements. This note will describe the nature of the event and the financial impact. This additional context is for a full understanding of the circumstances that led to the unusual cost.

Tax Deductibility Considerations

The Internal Revenue Service (IRS) does not use the “unusual” or “infrequent” labels from accounting. Instead, deductibility is determined by the “ordinary and necessary” test found in the Internal Revenue Code. An expense is ordinary if it is common and accepted in that trade or business, and necessary if it is helpful and appropriate for the business.

For tax purposes, “ordinary” does not mean recurring. An expense can be ordinary even if it only happens once, as long as it is a type of expense other businesses in the same industry might face. This means many costs classified as “unusual” for accounting can still be fully deductible.

For instance, legal fees from a lawsuit are an unusual event for accounting. For tax purposes, however, legal fees to defend the business are an ordinary and necessary expense. Repair costs after an unexpected fire could be an unusual loss for accounting but would likely be deductible as a necessary business expense.

Some unusual expenses are not deductible, such as government-imposed fines and penalties. Furthermore, some large, one-time costs may need to be capitalized rather than expensed. A capital expenditure is a cost that provides a benefit for more than one year, such as purchasing a new building, and these costs are depreciated over time rather than being deducted in a single year.

Required Substantiation and Documentation

To support the treatment of an unusual expense for financial audits and IRS inquiries, maintaining thorough documentation is required. The burden of proof is on the taxpayer to substantiate any claimed deduction. Without adequate records, an expense may be disallowed.

Documentation must prove the transaction occurred and was for a business purpose. For complex unusual expenses, additional documentation is necessary, such as:

• Invoices, canceled checks, bank statements, and detailed receipts
• Legal agreements and records of payment for lawsuit settlements
• Insurance reports, police reports, and property appraisals for natural disaster losses
• Internal memos, board meeting minutes, and third-party appraisals for asset write-downs

Records should be kept in an orderly fashion, organized by year and type of expense. This practice ensures compliance and provides a clear history of events that have impacted the company’s financial position.