Question

Your client, Sam, is a small business taxpayer. He is under the impression that every dollar he spends currently related to his business will reduce his taxable income.

Required:

1 - Why are some expenses not deductible? Provide an example of an expense to support your response.

2 - Explain what actions Sam could take to turn a disallowed expense into a deductible expense.

PS: Please thoroughly answer both questions

Answer 1

When you run a business, one of the greatest advantages you have is the ability to write off business expenses. A business expense is any expense which is incurred while doing business. While most expenses are deductible,some expenses are only partially deductible. In addition some expenses are not actually business expenses and therefore non-deductible. Some examples of such type of expenses are as follows:

1)Capital Expenses:capital expenses are expenses you incur to start a business while you might think of these as business expenses, the IRS doesn't considered them fully deductible business expenses. Capital expenses are not deductible for most part, though you might be able to deduct some portion of your capital or start up costs. In general you may deduct upto $5000 of business start-up costs.

2)Cost of goods sold:Cost of goods sold refers to the cost you incur for procuring your inventory. These costs are counted as expense,normally, on schedule C of your 1040 tax return. However the rules regarding cost of goods sold are confusing; it's easy to make serious error in your deductions. You may allocate certain expenses like inventory and labor costs under "cost of goods sold." if you do, you cannot deduct these same expenses elsewhere on your schedule C under business expenses or business losses.

3)Personal expenses: personal expenses may be mistaken for for business expenses. For example, if you use your vehicle to travel to and from work. You cannot deduct the mileage or the actual expense incurred for commuting. Personal expenses may also include using your cell phone for personal calls or using your business phone for personal use. Neither of these is deductible  

2) An expense does or doesn't meet the criteria for being tax deductible matters to be deducted or disallowed.

a) any expense relating to business will be deducted

b) any capital expenses and the expenses not relating to business are disallowed

c) some expenses are partially deductible and disallowed as well

d) some expenses like fines and penalties are disallowed as they are imposed for late payment of tax.

e) some other examples are bribes etc., which are disallowed

In order to avail deduction everything must be a business expense. So everything must be a business expense to avail deduction