What Are Ordinary and Necessary Expenses (O&NE)?
Let me explain what ordinary and necessary expenses are—they're the costs you incur as part of owning a business or carrying on a trade. For income tax purposes, these are categorized as ordinary and necessary, and they're generally tax deductible in the year you incur them.
These expenses come from Section 162(a) of the Internal Revenue Code, and they have to pass basic tests of being relevant to your business and necessary. The IRS doesn't provide a full list of what counts, so it's up to you as the taxpayer to figure this out.
Key Takeaways
You should know that ordinary and necessary expenses are generally the costs of owning a business. Common examples include business-related software for your computer or rental expenses. Also, portions of your home used for business can sometimes be tax-deductible.
Understanding Ordinary and Necessary Expenses (O&NE)
This part of the tax code leads to many deductions for individuals, especially when you're switching jobs or careers. You can include typical expenses like a work uniform or business software for your home computer in this category.
Startup costs for a new business might be deductible, but you usually have to spread them over several years—these are treated as capital expenses, not ordinary and necessary ones by the IRS.
The IRS says an 'ordinary' expense is something common and accepted in your specific trade or business. A 'necessary' expense is helpful and appropriate, but it doesn't have to be indispensable.
Key Examples of Ordinary and Necessary Business Expenses
- Employees Compensation: wages or salaries paid to employees for services rendered.
- Retirement Plans: money allocated to employee-sponsored retirement plans such as 401(k), 403(b), SIMPLE (Savings Incentive Match Plan for Employees), and SEP (Simplified Employee Pension) plans.
- Rental Expenses: money for a property a business owner leases but does not own. The rental expenditures are not deductible if the business owner receives equity in, or holds title to the property.
- Taxes: any local, state, federal or foreign taxes paid that are directly attributable to a trade or business.
- Interest: any interest expenses on money borrowed, to cover the costs of business activities.
- Insurance: any type of insurance acquired for a professional business.
More on Ordinary and Necessary
In general, 'ordinary' expenses are those commonly and typically used by people in your trade or industry. 'Necessary' expenses are those that are helpful and appropriate; to be tax deductible, necessary expenses must also be ordinary.
Business Use of Your Home
If you're a business owner, you may deduct expenses related to the parts of your home allocated for business use. These can include utilities, mortgage interest, and repairs. To qualify, you must prove your home is your principal place of business, even if you do some work elsewhere.
Deductions for a home office are based on the percentage of your home dedicated to business use, so you're responsible for calculating that.
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