There are certain costs you may incur for your company that make good business sense. Unfortunately, the tax law doesn’t view them all as write-offs. Here are a list of expenses you may incur in or related to your business but you can’t deduct them (in whole or in part) on your 2017 tax return. This article has been specially updated for the 2017/2018 tax season.
Non-Deductible Business Expenses
- Additional Medicare taxes. The 0.9% additional Medicare tax paid on net earnings from self-employment or employee wages (if your income is high enough) and the 3.8% net investment income tax paid on income from investments (things your business owns but doesn’t participate in on a day-to-day basis), again if your income is high enough, are personal taxes that are nondeductible.
- Clothing for work. While many people in business want to dress for success, the government doesn’t help to underwrite the cost by permitting a deduction. Only clothing not suitable to street use (e.g., uniforms, hardhats, etc.) can be deducted.
- Commuting to and from work. No matter how lengthy or difficult it is to get to your business and home again or what mode of transportation you use, you can’t write off the cost.
- Dues to a country club. Even though golf or tennis may be a great way to meet and network with clients and customers, the dues aren’t deductible. The same is true for social clubs and fitness centers. But if you have a business lunch at your club, half the cost of the meal can be deducted.
- Exploratory costs. The money you spend to research business opportunities you might go into isn’t deductible. Once you actually start a business, expenses treated as start-up costs can be deducted in the first year within certain limits.
- Fines and penalties. Government-imposed fines and penalties are usually nondeductible, regardless of the amount.
- Gifts to business associates, customers, vendors, etc. The deduction is capped at $25 even though it makes good business sense to give a more expensive gift in certain situations.
- Half of meals and entertainment costs. Only 50% is deductible in most cases. There are some exceptions, such as company picnics or break room snacks, when a deduction for the full cost is permissible.
- Interest on tax underpayments for noncorporate taxpayers. Sole proprietors and owners of pass-through entities that pay interest on tax underpayments cannot deduct them. The interest is viewed as personal interest even if it relates to business income.
- Legal fees to buy property. These fees are added to the cost basis of the property. A portion of the fees (the part allocated to the cost of the building and not the land) may be recovered through depreciation.
Starting in 2018, the list of nondeductible business expenses grows longer because of changes in the Tax Cuts and Jobs Act. While you may be able to deduct these items in 2017, you can’t do so going forward:
- Part of your interest expenses on borrowing if your average annual gross receipts for the three prior years exceeds $25 million
- Entertainment costs (e.g., taking a customer to a sporting or theatrical event)
- Reimbursements of employees’ commuting costs (e.g., free parking; monthly transit passes)
- Reimbursements of employees’ moving expenses
- Domestic production activities deduction
- Net operating loss carrybacks. Only carryforwards are allowed, and they can only be used to offset 80% of taxable income.
- Excess business losses for noncorporate taxpayers. The excess business losses are treated as a net operating loss carryover.
Impact of Nondeductible Business Expenses
Your “book income,” which is the net amount on your books and records, may not match up with your taxable income, which is used for tax reporting purposes. In other words, your net profits from a financial standpoint may not equal the net profits on your tax return.
The discrepancy is reconciled on Schedule M-1 of Form 1120 for C corporations, Form 1120S for S corporations, and Form 1065 for partnerships. You don’t have to complete the M-1 for the 1120S or 1065 if total gross receipts are less than $250,000 and total assets at the end of the year are less than $250,000 (for an S corporation) or $1 million for a partnership. However, it’s still a good idea to do so because it can answer questions that could be on an IRS examiner’s mind. Large entities — those with $50 million or more in assets — must use Schedule M-3 for this purpose. Those with $10 million to $50 million may use Schedule M-1 instead of Schedule M-3.
Sole proprietors and independent contractors filing Schedule C of Form 1040, regardless of the amount of gross receipts or assets, don’t have to do any reconciliation. But they should recognize that their financial statement is not necessarily identical to their tax return.
Remember to factor in 2018 changes in your estimated tax payments. Work with a CPA or other tax advisor to optimize your deductions and to understand how nondeductible items impact your taxes and financial statements.
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