 Income Tax 2021-2022, Business Expenses Introduction. Get ready to get refunds to the max, dive into Income Tax 2021-2022. Most of this information can be found in Publication 334, Tax Guide for Small Business Tax Year 2021, looking at the Income Tax Formula Line 1 income, although there would be a supplemental schedule, basically an income statement with income and expenses were focusing in on the expense side of things here, expenses basically being deductions, the net then rolling in to line 1 income of the income tax formula as well as page 1 of the tax return form 1040 where we would have the schedule C, basically the income statement rolling then in to the schedule 1, schedule 1 rolling then in to page 1, form 1040 line number 8. See here, we've got the profit, we've got the schedule in C, schedule C, profit or loss from business, basically an income statement. Now we're looking at the expenses side of things, introduction to that expenses side of things here, noting as we think about expenses in practice or in life then the expenses usually being a bad thing in the tax world, however, expenses are basically a good thing because they're basically deductions, lowering our net income. If the net income is lower, then that's usually a good thing for taxes. So in general, 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, meaning you don't have to basically put them on the books as like an asset, which when you're talking about the tax code, we only really see the income statements and we don't see the balance sheet, but we would be putting them on the books as an asset. They do have a subschedule of things that you might have to capitalize, things like depreciable assets on a subschedule for the tax return, recording those assets as well as the depreciation related to them or include in the cost of goods sold. Now the cost of goods sold is kind of like an expense. It's going to be a good thing for taxes as well. But we go into a special calculations that we've talked about in the past related to the cost of goods sold, but can deduct in the current year. That's the point with the expenses. We want to deduct them in the current year as opposed to capitalizing them and possibly getting a deduction in the future, possibly with something like a depreciation type of expense in that instance. Now the expenses for the business are more straightforward than other kinds of expenses that you might see on like a schedule A, for example, because the general idea of expenses, if you were just to create an income tax system, make more sense to moat to some degree on the schedule C than they do on some of the deductions on say like a schedule A, because income tax you would think would be unfair to tax the top line, the gross income, how much you brought in in terms of gross income, but rather it should tax the bottom line after the expenses, after the things that you had to consume in order to generate the revenue so that it would be taxed on basically the net income. And that's the natural process that you would think with an income tax. So you would think that those expenses that you needed to expand in order to generate the revenue in the same time period would be deductible expenses so that you're taxed then at the net income. The same general rule applies to all of the income taxes as well, although then the tax code comes in and puts other kind of deductions in place that don't quite follow that rule. And you can try to rationale why they did it and so on like you got charitable deductions which obviously don't exactly follow that rule because you don't have to give to charity that they weren't giving to charity in order to generate the revenue, but we're trying to incentivize the charity giving so you can see why they might have a deduction like that. If you deduct mortgage interest, for example, the mortgage interest is based on a loan that's based on the home and the home is personal. So it doesn't seem like why would you be deducting that? You could say that you can rationalize it and say that well they did it so that everyone can buy a home or possibly if you're more cynical to appease the lobbyists that are all related to the housing market and what not in order to increase their bottom line. But the on the incomes on the on the schedule C type of stuff, it's pretty that's pretty straightforward. Kind of following more closely the general rule to be deducting or applying the tax to the net income. So to be deductible a business expense must be both ordinary and necessary. So those are the key terms ordinary and necessary and ordinary expense is one that is common and accepted in your field of business. So this gets a little bit tricky in different fields of business. So if you're in like a boring field of business like if you're if you're in an accountant if you're as I know the field that I'm that I'm in if you're an accountant, the IRS probably doesn't see the accountant as a as a very as something that you might do like as a hobby although I think it's a great time good ways past time and what not. But in any case the IRS probably doesn't see it that way. So you would think that the expenses that would be related to some a job like that then would be would be pretty clearly deductible. If you have a job that looks a little bit more more like it could be of a hobby type of thing, say you are your photographer or something like that and you deduct things that might be business related for like vacation time or travel time or watching movies or something like that then you could see why the IRS might be more skeptical as to whether it be ordinary and necessary. Now if those types of things that that look kind of more like a fun type of thing something that you might do on a vacation or something like that are actually part of your work then they might be ordinary and necessary to that particular business even though in my business the IRS would almost certainly say no your trip to the Bahamas wasn't deductible right. I mean even though you know you might try to see some business purposes for it but no we're you know probably probably not whereas if you go into the Bahamas to take pictures of you know the ocean there or something and your photographer maybe then it would be an ordinary and necessary so that will be dependent on kind of like the industry. A necessary expense is one that is helpful and appropriate for your business and expense does not have to be indispensable to be considered necessary. So in other words what is necessary from a philosophical standpoint what is it that we really need? Not much I mean I've got my food I've got my water so that's not really what we're looking for to see whether it be deductible or not it's not like if you didn't have this particular expense my business would die that's not the level or the bar that we have to clear in order to be able to deduct it so ordinary and necessary for the business. So for more information about the general rules for deducting business expenses see chapter one of publication 535 so if you got if you want to get more into depth on that you can find out of the IRS website if you have an expense that is partially for business and partially for personal here's where it gets confusing separate the personal part from the business part but they're stuck together really tight the personal part is not deductible. So this is where many small businesses have a lot of problems of course because we're going to have some mending between our personal and business lives and we're trying to separate them and you want to do that not just for taxes but if you can basically separate the two things that you're focused on you're more likely to be able to achieve your goals because you're able to kind of focus in on those specific things more so on the business side of things clearly you'd like to separate the stuff that's on the business side so you can see if you're achieving at least one of the big goals which is revenue generation which is more difficult to do if everything is kind of mingled together and on the personal side whatever your goals on the personal side might be which is much more varied than revenue generation then you might be if you separate those things out you might be able to kind of isolate those goals and possibly be able to achieve them a little bit more easily as well but no matter what we do on a small business we have we might have some things that are kind of tied together so classic examples of this would be like an auto which the automobile that we use possibly for business and personal so we got to get into deductibility of that that we might talk about in future presentations the home we might work from home if we're especially for a schedule C type of business especially in the last couple years when you're locked in your home anyways and so you might be working from there and you've got whatever you paid for the home whether it be the rent or the mortgage on it that that's your pain and so how much of that could possibly be on both sides it could basically be deductible so these are types of things where it's difficult to to separate them but we want to be able to separate them in some way so that we can determine the deductible portion of it which would be the things that are going to be ordinary and necessary for the business versus the personal portion of them which would not be deductible unless they fall into some other kind of random candidate category that they made up over here something like interest on the on the home that that then you could have part of it that could be part of the business and you might have part of it that you could allocate still then to a schedule A as it being deductible for some other purpose so more information on this stuff can be found in publication 463 that gets into the travel gift and car expenses which is a common area that people have issues with publication 535 business expenses publication 946 how to depreciate property.