With 2025 behind us and the tax filing deadline approaching, now is the time for businesses to review which expenses qualify as deductions. The rules aren’t always straightforward, and what counts as deductible may surprise you.
The General Rule
Most deductions aren’t spelled out in the Internal Revenue Code (IRC). Instead, IRC Section 162 provides the guiding principle: businesses can deduct “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Importantly, expenses must also be properly documented.
Ordinary and Necessary Expenses
An expense is considered ordinary if it’s common or customary in a particular industry. For example, a landscaping company’s fuel and equipment maintenance costs are ordinary because they’re typical for that business.
A necessary expense is one that’s helpful or appropriate. A retail store may not need security cameras to operate, but installing them is considered necessary because they help reduce theft and protect staff and customers.
To qualify as deductible, an expense must be both ordinary and necessary. For instance, buying tools is ordinary for a construction company, but upgrading to premium, top-of-the-line equipment when standard tools suffice may be deemed unnecessary and therefore not deductible.
IRS and Court Examples
The IRS and courts often disagree with taxpayers about what qualifies as deductible. Documentation is frequently the deciding factor. Sometimes, the issue is whether the taxpayer is truly operating a business.
- In one case, the Tax Court denied deductions for an engineering firm owner who tried to claim the value of his own time spent developing software. Because self-performed labor isn’t “paid or incurred,” it wasn’t deductible.
- In another case, a taxpayer involved in real estate activities was denied deductions because the court ruled the activities were investment-related, not an active trade or business. The lack of adequate records further weakened the claim, and the Ninth Circuit upheld the denial.
What Can You Deduct for 2025?
Determining which expenses are deductible can be complex, and proper substantiation is essential. Careful recordkeeping and professional guidance can help ensure your 2025 tax return reflects legitimate deductions.