A recent tax court ruling landed in favor of the IRS. The court ruled that paying or incurring an expense is not sufficient to entitle the taxpayer to a deduction. The taxpayer also has to ensure that there is a purpose underlying the deduction and that it is “ordinary and necessary” to operating their trade or business.
What does this mean for small business owners? If you are an advisory client of The Forde Firm, and you are following our expensing rules and documentation requirements, it won’t make much difference for you. If you have decided that you will walk on a line about meals and entertainment or laundry and dry cleaning or other items, it is a clear warning from the tax court that the IRS has every right to deny those deductions. The purpose of this case in tax court was to disallow items that the IRS believed were personal rather than business related.
In the case mentioned, the taxpayer was operating as a sole proprietor; however, this could apply to other types of entities as well, if the IRS determines there isn’t a valid business purpose. In this case the taxpayer also didn’t keep receipts and detailed records. The IRS has been clear that having a credit card statement is not sufficient and that receipts with details must be maintained.
The IRS has a full publication explaining business expenses. Publication 535 Publication 535 (2022), Business Expenses | Internal Revenue Service (irs.gov). It is over 50 pages long and does have good information and detail in it. This publication defines ordinary as an expense that is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.
We have advisory packages with guidance, training and tools to use to help you document your records so that if you are audited, you can support your legitimate business purpose of your transaction and that it is ordinary and necessary. We also have an audit support package that can help you if you receive a notice that requires a response to the IRS. Don’t leave interactions with the IRS to chance. Make sure you know what is and isn’t deductible for your business and that you have the documentation to prove it.