26 Nov 2009

US tax deductions - Small business Expenses

by Darren

Under US tax law to be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your business. It is important to separate business expenses from the following expenses:
  • The expenses used to calculate the cost of goods sold,
  • Capital Expenses, and
  • Personal Expenses.
Cost of Goods Sold If your business manufactures products or purchases them for resale, you generally must value your inventory at the beginning and end of each tax year to determine your cost of goods sold. Cost of goods sold is deducted from your gross income to to determine your gross profit. Once an expense is included in your cost of goods sold, you cannot deduct it again as a business expense. The following are types of expenses maybe included:
  • Cost of products or raw materials, including freight
  • Storage
  • Direct labor costs
Capital Expenses You must capitalize, rather than deduct, certain costs. Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize.
  • Business start-up cost
  • Business assets such as furniture, buildings, computer equipment
  • Improvements
Personal versus Business Expenses Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for your business and partly for personal purposes, you may split the total cost between business and personal and deduct the business component. For example, if you borrow money and use 70% of it for business and the other 30% for the purchase of a car for personal use, you are entitled to deduct 70% of the interest as a business expense. The remaining 30% is personal and not deductible. This is a general overview if business deductions. We will go into the detailed expenses and their deductibility over the next few US related entries

Next entry: Tax Deductions for small businesses in Singapore
Previous entry: General Deductions Under The Income Tax Ordinance


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