 Income Tax 2022-2023 Business Expenses Introduction Let's do some wealth preservation with some tax preparation Support Accounting Instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course Each course then organized in a logical reasonable fashion making it much more easy to find what you need than can be done on a YouTube page We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable So once again click the link below for a free month membership to our website and all the content on it Most of this information comes from the Tax Guide for Small Business for Individuals Who Use Schedule C Publication 334 Tax Year 2022 You can find on the IRS website irs.gov, irs.gov Looking at the income tax formula we're focused on line one income Remember in the first half of the income tax formula is an essence and income statement Although just an outline the scaffolding other forms and schedules flowing into these line items The Schedule C being one of them it in essence being an income statement in and of itself with business income minus business expenses the net then flowing into line one income here of our income tax formula Page one of the form 1040 the Schedule C would flow in then to the Schedule 1 flowing then in here to page one of form 1040 line 8 Schedule C profit or loss from business here's the income statement where we have income minus expenses We're now looking at the expenses side of the Schedule C which is in essence an income statement We have the income minus the expenses Now although we're hoping that the income in total dollar amount is greater than the expenses in total dollar amount the expenses are often more confusing because there's many more categories of expenses than income and that's just the nature of the business generally because when we're in business what we're typically doing is trying to get really good honing down specializing our knowledge and skills on a particular item all income then being categorized as that particular item typically whereas on the expense side of things everything else that we're not specializing on we are paying for and that of course are all the categories of the expenses so when we're thinking about business expenses we can also categorize them as business deductions and when we think about the income statement in general or income taxes I should say in general note and recall the general rule in an income tax system we should be able to deduct those things that are necessary in order to generate the revenue so we're not taxing people on gross income but rather on the net income and when we're thinking about people that don't have a business they have W2 income that gets a little bit confusing because if you have W2 income the assumption by the government is that the employer is the one that's giving you everything that is necessary in order to do the job therefore we don't have those normal kind of what we would think of as like normal expenses for an income tax system instead we focus on all the weird things which is basically the government trying to influence us in certain ways influence us to save for retirement influence us to buy a home influence us to pay charity or give to charity and I'm not saying these things are good or bad I'm just saying the tax code is a tool to kind of manipulate our behavior and that's where a lot of the expenses on the above the line deductions and the Schedule A deductions are so and it kind of shifts our focus to the normal natural type of expenses which are basically what we see on a Schedule C because the expenses should be those things you would think that you had to consume in order to generate the revenue so most of the time the expenses the business deductions on the Schedule C are more natural to what you would think of happening in an income tax type of system okay so you can deduct the costs of operating your business these costs are known as business expenses these are costs you do not have to capitalize or include in the cost of goods sold but can deduct in the current year so when we're thinking about the expenses then there's a matching principle which is generally kind of an accrual type of principle so we talked about in prior presentations a cashed based system versus an accrual based system but even if you're using a cashed based system we still have this matching concept to some degree because if there's a substantial deviation from a cashed based system they force us to do some accrual concept stuff for example if we purchase a large piece of equipment even if we pay cash for it we can't just deduct the $100,000 piece of equipment but rather usually have to put it on the books as an asset and then use some kind of depreciation method possibly still getting 100% of the depreciation if there's $179 or special depreciation but the point is the general idea is that we'd have to put it on the books as an asset and then allocate the expense and that's a matching concept because we're trying to match out the consumption when we actually used the thing in order to generate the revenue in the same time period so to be deductible a business expense must be both ordinary and necessary so those are the key terms and from just a general standpoint they mean what kind of you would expect them to mean right they're going to be ordinary and necessary type of business expenses you needed those business expenses in other words in order to help you to generate the revenue so an ordinary expense is one that is common and acceptable in your field of business so if we were to take a look at the type of expenses that you have in your particular business we would expect you would think to see similar expenses in other types of businesses obviously when you get into certain or different businesses then you can find some expenses where you would think that if you were looking at them and you didn't know the industry you would say that doesn't look like a business expense that looks like for example personal and one of the main things we need to do is be separating business from personal but for example if someone is a professional photographer then they might be taking a lot of trips to very beautiful places where if you were sitting in an IRS tax office or IRS office looking at it saying this guy is traveling to the Bahamas or something you might be saying hey that looks like a personal kind of thing and it seems that it may be somewhat personal because obviously part of their business is that's why they chose that business most likely right it would be you would think a business expense because they're traveling there in that case for the particular photography and so on but you can see where the line gets fuzzy between taking trips and stuff like that meals and those kind of things between personal and business and that's where things get a little bit hazy and necessary expense is one that is helpful and appropriate for your business so an expense does not have to be indispensable to be considered necessary so when you say necessary like it's like when someone says I need this and it's like do you really need this like when someone says I need that candy bar or something do you really need it you know because you could probably so if you took it the candy bar away would you die no so maybe so maybe it would be a good thing to have but maybe it's maybe you don't need it same thing for the business here obviously you could say if the argument or the benchmark to clear was if I took this this expense away with the business crumbled to pieces that's not that's not the the bar to clear that would be a high bar it's an expense does not have to be indispensable to be considered necessary so that means that that necessary term is somewhat gray so we're going to have to use some judgment on these terms as we think about ordinary and necessary so for more information about the general rules for deducting business expenses you can see chapter one of publication 535 caution if you have an expense that is partly for business and partly for personal separate the personal part from the business part now this is one of the key conditions one of the key problems that we have when we're thinking about expenses because now we're saying you're allowed to deduct these expenses that means that these expenses now are good for taxes which means that people are going to try to increase their expenses and you know you would think that they're having incentive people have an incentive at least to try to bloat increase the expenses how would they do that it's not like they don't want to have an unprofitable business they want to have a profitable business but still be inflating their expenses for taxes so they don't have to pay taxes on it so what do you what would happen then people are going to try to conflate you would think the business versus the professional and that's where it gets muddy the muddy situation so it's easy in concept to say that you need to break out your business versus the professional but when you get into specific items it gets again it gets a little bit confusing when you're taking business trips and we'll get into some of the details and a little bit a little bit more detail here but that's of course what we want to watch out for we want to try to separate as best we can the business versus the personal if you're doing a trip somewhere that has business and personal stuff to it you're supposed to parse those things out so that you deduct only the business part because you don't get to deduct vacations because no one else gets to deduct vacations so it wouldn't be fair so the personal part is not deductible that's the point publication useful items you may want to see you've got four six you got the publications four six three travel gift and car expenses publication five three five business expenses so when we get into these items you'll see that some expenses are pretty straightforward if you paid if you paid for something directly for the business you paid for supplies that are for the business then that's a pretty straightforward type of thing if you paid the utility bill for an office that's used exclusively for the bent business if you're paying rent somewhere that's used to not a problem but if you're thinking about things that could have a personal component to it if you're using a home office for example and you're paying the utility bill that covers your home your whole home then it gets messy how much do I get to deduct and there if you're traveling that's clearly could be a messy situation in terms of is there any personal side to the travel is there business side and personal side are you mixing these things together are you mixing the personal the business together because then car obviously is a problem because you might be using the car for personal and business expenses so those are some of the ones to drill down on you've got the publication five three five business expenses to check out the six four seven publication how to depreciate property depreciation is also another just messy situation the idea being that you can't expense something in the year that you bought it if it's a large item because of this big timing difference between when you bought it and when you're going to get the consumption using the matching principle trying to match the consumption when you used it to the same period that you generated the income so then you have this depreciation concept which is a standard accrual concept that you might understand conceptually from an accrual standpoint but even once you do that the tax code still messes that all up because then the tax law people come in and say hey look we want to have accelerated depreciation or one seventy nine depreciation to try to stimulate the economy so now you've got depreciation schedules that don't mirror what you would think they would from an accounting standpoint because they have again other incentives in place they're trying to stimulate people's behavior or just people's behavior through the tax code and so they mess up all the depreciation schedules to make them all weird and not make any sense from an accounting standpoint and we have to deal with that being different possibly than the booking depreciation which we do want to make sense unless we want to keep our books on a tax basis so it's easier so these are questions that come up on the website which we may dive into so in any case c-chapter twelve for information about getting publications and forms you can check out the iris website if you want to look at these in more detail and we'll dive into some of these topics in future presentations