You may incur certain costs for your company that make good business sense. Unfortunately, the tax law doesn’t view them all as write-offs.
Check out this list of business expenses that remain non-deductible (in whole or in part) these expenses on your 2019 tax return.
NOTE: This article has been specially updated for the 2019/2020 tax season.
Non-Deductible Business Expenses
- Additional Medicare taxes. You pay 0.9% additional Medicare tax on net earnings from self-employment or employee wages (if your income is high enough.) You also pay the 3.8% net investment income tax on income from investments. That includes income from a business in which you don’t participate on a day-to-day basis. Again you pay these if your income is high enough. They remain 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. 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.
- Entertainment costs. No portion of the cost of tickets to the theater or sporting events to entertain clients, customers, vendors, or other business associates is deductible.
- 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.
- Interest expense payments. Part of your interest expenses on borrowing if your average annual gross receipts for the three prior years exceeds $26 million.
- Payments of certain employee expenses. Reimbursements of employees’ commuting costs (e.g., free parking; monthly transit passes) and reimbursements of employees’ moving expenses are not deductible.
- Net operating loss carrybacks. Only carryforwards are allowed (other than for farmers), and they can only be used to offset 80% of taxable income.
- Excess business losses for noncorporate taxpayers. You must treat these excess business losses as a net operating loss carryover.
- Hobby losses. Engage in a business without the intention of making a profit? You must then report all income but can’t deduct expenses.
Impact of Non-Deductible Business Expenses
Your “book income,” makes up the net amount on your books and records. It may not match up with your taxable income. You use this number for tax reporting purposes. In other words, your net profits from a financial standpoint may not equal the net profits on your tax return.
Reconcile the discrepancy on Schedule M-1 of Form 1120 for C corporations, Form 1120S for S corporations, and Form 1065 for partnerships. Do total gross receipts equal less than $250,000? Do total assets at the end of the year make up less than $250,000 (for an S corporation) or $1 million for a partnership? Then you don’t need to complete the M-1 for the 1120S or 1065. However, you still may wish do so. Because it may 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 file Schedule C of Form 1040 or 1040-SR. This happens regardless of the amount of gross receipts or assets. So they need not have to do any reconciliation. But they should recognize that their financial statement is not necessarily identical to their tax return.
Work with a CPA or other tax advisor to optimize your deductions and to understand how nondeductible items impact your taxes and financial statements.