With 2025 behind us and the upcoming tax filing season ahead, now is the ideal time for business owners to review their records and identify which expenses may qualify as deductions. However, knowing what is truly deductible is not always as straightforward as it may seem. Many business expenses fall into gray areas, and proper interpretation — along with strong documentation — is essential.
Understanding the IRS Standard: “Ordinary and Necessary”
Most deductible business expenses are not specifically listed in the Internal Revenue Code. Instead, the IRS relies on the foundational rule under Section 162, which allows deductions for “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” To claim a deduction, a business must also be able to clearly substantiate the expense.
An expense is considered ordinary if it is common and customary within a particular industry. For example, a landscaping company’s fuel, maintenance, and equipment servicing costs would typically qualify because such expenses are normal and expected for that type of business.
An expense is considered necessary if it is helpful or appropriate for operating the business — even if it is not essential. For instance, a retail store may operate without security cameras, but investing in them is appropriate for reducing theft risk and protecting employees and customers.
To qualify as deductible, an expense must meet both standards. An expense may be ordinary yet not necessary if it is excessive or unreasonable compared to the business purpose. For example, if a construction company replaces perfectly functional, professional-grade tools with ultra-premium upgrades solely for preference, the expense may no longer be considered necessary or reasonable — and deductibility could be challenged.
When the IRS or Courts Disagree
Even when business owners believe expenses are valid, the IRS or courts may rule otherwise. In many cases, the issue is not the expense itself but the lack of proper documentation — or whether a true trade or business was being operated.
In one court case, the owner of an engineering firm attempted to deduct the value of his own labor while developing a software program. The court denied the deduction, ruling that self-performed labor is not “paid or incurred,” and therefore does not qualify as a deductible expense.
In another case, a taxpayer engaged in various real estate activities claimed business deductions, but the Tax Court determined the properties were held for investment rather than an active trade or business. The deductions were further denied because adequate records were not maintained. On appeal, the Ninth Circuit Court upheld the ruling, noting the taxpayer failed to provide sufficient proof to support the claimed deductions.
What Can Your Business Deduct for 2025?
Determining whether an expense is deductible requires more than simply classifying it as a business cost. The expense must be ordinary, necessary, reasonable in amount, and fully documented with clear records and a legitimate business purpose.
As you prepare your 2025 tax filings, working with an experienced advisory firm can help ensure you are maximizing allowable deductions while staying compliant with IRS rules.
Botwinick & Co. can help you evaluate your expenses, review documentation requirements, and determine what your business may deduct on its 2025 tax return.
Contact us today to discuss your tax strategy and year-end planning.
