What it means
To be deductible, a business expense generally has to be both ordinary and necessary. Ordinary means common and accepted in your trade, and necessary means helpful and appropriate for the business.
Personal living costs are not deductible, so a key skill is separating business spending from private spending. Publication 535 works through the main categories.
It covers the cost of goods sold, employee pay and benefits, rent, interest, taxes, insurance, repairs, travel and other items. It also explains when a cost must be treated as a capital item, spread over several years, instead of deducted at once.
One important topic is start-up costs, the money spent before a business opens, such as market research, training and advertising. Rules have allowed a limited amount to be deducted immediately, with the remainder spread over a fixed period.
Because these amounts and periods are set by law and can change, check the current edition. The guide also explains amortisation, which is the gradual write-off of the cost of an intangible or long-lived item over time.
It is the same idea as depreciation for physical assets. Understanding the difference between a deduction in one year and a spread-out deduction matters for cash flow and for how profit looks in each period.
Good records are the foundation of any deduction. The publication points out that receipts, invoices and logs support the claim and that a tax authority can ask for proof.
For small business owners, reading it alongside the guides on recordkeeping and depreciation gives a practical picture of what to claim and what to keep. Timing is another theme.
Most small businesses use the cash method, deducting expenses when they are paid, while larger ones must use the accrual method, deducting them when they are incurred. Choosing the wrong method, or switching without permission, can distort profit and attract questions from the tax authority.
In practice
Real-world examples.
Example
A cafe owner pays $2,400 a month in rent and $600 for liability insurance. Both are ordinary and necessary, so she deducts them as business expenses in the year they are paid or incurred.
Example
A consultant buys a $3,000 computer used only for work. The publication and related guides help him decide whether to deduct it at once or spread the cost over its useful life.
Example
A founder spends $30,000 on market research and legal fees before launching a bakery. She uses the guide to treat part of it as an immediate deduction and the rest as costs written off gradually.
Formula
Calculation
Immediate deduction for start-up costs = allowed amount - amount by which total costs exceed the phase-out threshold
Monthly amortisation of the rest = remaining costs / number of months in the amortisation period
In the rules described in the publication, up to $5,000 of start-up costs could be deducted at once, reduced dollar for dollar once total costs passed $50,000, with the balance spread over 180 months. A founder spends $50,000 on start-up costs before opening. Because the total does not exceed $50,000, she deducts the full $5,000 in the first year. The remaining 50,000 - 5,000 = $45,000 is amortised over 180 months, giving 45,000 / 180 = $250 a month. These figures are set by law and can change, so confirm them for the year in question.Case study
Seen in the real world.
Maplewood Furniture is an illustrative, fictional workshop run by two partners. Their bookkeeper noticed that the previous owner of the equipment had deducted the full price of a $40,000 machine in one year, while the publication and linked guides required the cost to be recovered over time.
She reviewed the rules, set up a schedule that spread the cost over the machine's recovery period, and corrected the books for the earlier year. She also separated personal car expenses from business mileage, which removed $3,200 of costs that did not qualify.
The illustrative lesson is that careful classification at the start prevents later disputes. The partners adopted a monthly review in which every expense is labelled as ordinary and necessary, capital or personal.
Watch out
Common mistakes.
- Deducting personal expenses as business costs, when only ordinary and necessary business spending qualifies.
- Deducting a large asset purchase in one year without checking whether it must be capitalised and written off over time.
- Using an old edition of the publication, when limits and rules are updated by new legislation.
Questions
People also ask.
What does ordinary and necessary mean?
An ordinary expense is common in your type of business, and a necessary expense is helpful and appropriate, though not necessarily essential.
Is the publication only for large businesses?
No, it is written for small business owners and sole traders as well as bigger firms.
What records should I keep?
Keep receipts, invoices, bank statements and mileage logs that show the amount, date and business purpose of each expense.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related