Taxes can be a real headache for business owners, especially when it comes to figuring out which expenses you can and can’t deduct. Fortunately, the IRS provides a handy guide to help businesses navigate this complex landscape: Publication 535, also known as Business Expenses.
This publication breaks down everything you need to know about deducting business expenses, from the basics of what qualifies as a deduction to the specific rules for different types of expenses.
But let’s be honest, IRS publications aren’t exactly known for their user-friendliness. They can be dense, jargon-filled, and difficult to understand.
That’s why we’ve put together this 101 guide to IRS publication 535, designed specifically for small and medium-sized business owners. We’ll break down the key takeaways from each chapter in plain and simple English so you can understand what you need to know without getting bogged down in the details.
What is IRS Publication 535?
IRS Publication 535 is a comprehensive guide to business expenses, covering everything from the general rules for deducting expenses to the specific rules for different types of expenses.
How is IRS Publication 535 Different from Other Publications?
IRS Publication 535 differs from other IRS publications in that it focuses specifically on business expenses. Other publications may cover various topics, such as individual income taxes or tax-exempt organizations.
A Breakdown of IRS Publication 535
The following section summarizes key information from IRS Publication 535. For more detailed information and official guidance, please refer to the full publication on the IRS website.
Why is It Important for Businesses to Understand Tax-Deductible Expenses?
Businesses need to understand deductible expenses because they can significantly reduce your tax liability. Bu deducting eligible expenses, you can lower your taxable income and pay less in taxes.
Chapter 1: Deducting Business Expenses
What Are Ordinary And Necessary Expenses?
Ordinary and necessary expenses are those that are common and accepted in your industry and are helpful and appropriate for your trade or business.
For example, if you own a bakery, the cost of flour, sugar, and eggs would be considered ordinary and necessary expenses.
What Is Cost Of Goods Sold, And How Does It Affect Deductions?
Cost of Goods Sold (COGS) includes the cost of materials, labor, and overhead directly related to producing the goods you sell.
Gross Profit = Gross Receipts (Sales) - COGS
Your gross profit is the amount you’ll pay taxes on.
For example, if your bakery has $500,000 in sales and $200,000 in COGS, your gross profit is $300,000.
What Are Capital Expenses, And How Are They Recovered?
Capital expenses are costs that add value to your business assets or extend their useful life, such as buying equipment or making improvements to your property. These expenses aren’t deducted immediately but recovered over time through depreciation, amortization, or depletion.
For example, if you buy a new oven for your bakery, you would depreciate the cost of the oven over its useful life.
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How Do You Distinguish Between Business And Personal Expenses?
Business expenses are those that are incurred specifically for your business operations. Personal expenses are those that are not related to your business. You can only deduct expenses that are directly related to your business activities.
For example, you can deduct the cost of your bakery's utilities, but you can't deduct the cost of your home utilities.
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What Are The Rules For Deducting Expenses For Business Use Of Your Home?
If you use part of your home exclusively and regularly for business, you may be able to deduct expenses like mortgage interest, insurance, utilities, repairs, and depreciation. There are specific requirements you must meet to qualify for this deduction.
For example, you must use the space exclusively for business, and it must be your principal place of business.
What Are The Rules For Deducting Expenses For Business Use Of Your Car?
If you use your car for business purposes, you can deduct expenses like gas, oil, repairs, insurance, and depreciation. You can either track actual expenses or use the standard mileage rate.
For example, if you drive 10,000 miles for a business in a year and the standard mileage rate for 2025 is 70 cents per mile, you can deduct $7,000.
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How Much Can You Deduct For Business Expenses?
Generally, you can deduct the full amount of ordinary and necessary business expenses. However, there are limitations and exceptions to this rule.
For example, there are limits on how much you can deduct for meals and entertainment expenses.
When Can You Deduct Business Expenses?
When you can deduct an expense depends on your accounting method. Cash-method taxpayers deduct expenses when they pay them, while accrual-method taxpayers deduct them when they incur the liability.
For example, if you're a cash-method taxpayer and you buy supplies for your bakery in December but don't pay for them until January, you would deduct the expense in January.
What Are The Rules For Deducting Expenses For Not-For-Profit Activities?
If you're not carrying on your business to make a profit, you can't deduct losses from that activity to offset other income. There are specific rules for determining whether an activity is for-profit or not.
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Most Common Business Expenses You Can Write Off
Here are some of the most common business expenses that you can deduct:
- Office Supplies: This includes items like stationery, paper, pens, printer ink, staplers, folders, and other office essentials.
- Travel Expenses: If you travel for business purposes, you can deduct expenses like airfare, lodging, meals, rental cars, and taxis.
- Utilities: This includes expenses like electricity, gas, water, trash service, and internet service.
- Rent: If you rent office space or other property for your business, you can deduct the rent payments.
- Insurance: You can deduct premiums for business-related insurance policies, such as liability insurance, workers' compensation insurance, and property insurance.
- Employee Salaries and Benefits: You can deduct the cost of salaries, wages, and benefits for your employees, including health insurance premiums, retirement plan contributions, and paid time off.
- Marketing and Advertising Costs: You can deduct the cost of marketing and advertising your business, including online advertising, print advertising, and promotional materials.
- Depreciation: You can deduct the cost of depreciable assets, such as buildings, equipment, and vehicles, over their useful life.
- Professional Fees: You can deduct fees paid to professionals, such as accountants, lawyers, and consultants.
- Bad Debts: If you've written off a bad debt, you can deduct the amount of the debt.
- Education and Training Expenses: You can deduct expenses for education and training that maintains or improves skills required in your business.
- Bank Fees: You can deduct bank fees that are related to your business, such as monthly service charges and transaction fees.
- Home Office Expenses: If you have a dedicated home office, you can deduct a portion of your home-related expenses, such as rent, utilities, and insurance.
- Business-Related Subscriptions: You can deduct the cost of subscriptions to business-related publications and software.
- Retirement Plan Contributions: You can deduct contributions to retirement plans for yourself and your employees.
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Chapter 2: Employees’ Pay
What Are The Tests For Deducting Employee Pay?
To be deductible, employee pay must be ordinary and necessary, reasonable, and for services performed.
For example, if you pay your employees a reasonable salary for the work they do, you can deduct those salaries as a business expense.
What Are The Different Kinds Of Employee Pay?
Employee pay can include salaries, wages, bonuses, commissions, awards, fringe benefits, and reimbursements.
For example, you can deduct the cost of your employee's health insurance premiums.
Chapter 3: Rent Expense
What Is Rent, And When Is It Deductible?
Rent is any amount you pay for the use of property you don't own. It's deductible if it's for property used in your trade or business.
For example, you can deduct the rent you pay for your bakery's storefront.
What Are The Rules For Deducting Rent Paid In Advance?
Generally, rent paid in advance is deductible in the year it's paid or incurred. However, there are special rules for accrual-method taxpayers and for payments that cover more than 12 months.
For example, if you pay rent for the next 12 months in December, you can deduct the entire amount in December if you use the cash method of accounting.
How Do You Deduct Taxes On Leased Property?
You can deduct taxes on leased property as additional rent. The timing of the deduction depends on your accounting method.
For example, if you're a cash-method taxpayer paying property taxes on your leased storefront in June, you can deduct the taxes in June.
What Are The Rules For Deducting The Costs Of Getting A Lease?
Costs of getting a lease, such as payments to the previous lessee, are amortized over the term of the lease.
For example, if you pay $10,000 to take over a lease with 10 years remaining, you can deduct $1,000 per year for 10 years.
What Are The Rules For Deducting Improvements By Lessees?
Improvements made by lessees to the property are depreciated over their useful life, not the term of the lease.
For example, if you install new ovens in your bakery, you would depreciate the cost of the ovens over their useful life, even if your lease is shorter than the ovens' useful life.
When Do You Have To Capitalize Rent Expenses?
You may have to capitalize rent expenses under the uniform capitalization rules if you produce or acquire property for resale.
For example, if you rent a warehouse to store ingredients for your bakery, you may have to capitalize the rent expense as part of the cost of your inventory.
Chapter 4: Interest
How Do You Allocate Interest For Business, Personal, And Investment Activities?
If you use loan proceeds for more than one purpose, you must allocate the interest based on how the funds were used.
For example, if you use 70% of a loan to buy equipment for your bakery and 30% to pay for a family vacation, you can deduct 70% of the interest as a business expense, and the remaining 30% is non-deductible personal interest.
What Is The Interest Expense Limitation?
There's a limit on how much business interest expense you can deduct each year. This limitation is designed to prevent businesses from deducting excessive interest payments. The limit is generally 30% of your adjusted taxable income.
What Interest Can You Deduct?
You can deduct interest on loans used for business expenses as long as you meet certain requirements.
For example, you must be legally liable for the debt, and you and the lender must have a true debtor-creditor relationship.
What Interest Can't You Deduct?
You can't deduct personal interest, interest that must be capitalized, or interest on certain life insurance policies.
For example, you can't deduct the interest on your home mortgage.
When Do You Have To Capitalize Interest?
You have to capitalize interest on debt used to produce real property or certain tangible personal property for use in your business or for sale to customers.
For example, if you take out a loan to build a new bakery, you would capitalize the interest on that loan as part of the cost of the building.
When Can You Deduct Interest?
The timing of the interest deduction depends on your accounting method. Cash-method taxpayers deduct interest when they pay it, while accrual-method taxpayers deduct it as it accrues.
For example, if you're a cash-method taxpayer paying interest on a business loan in June, you can deduct the interest in June.
What Are The Rules For Below-Market Loans?
Below-market loans are loans where no interest is charged, or the interest rate is below the applicable federal rate. There are special rules for these loans, which may require you to impute interest income and expense.
For example, if you receive a below-market loan from a family member to help start your bakery, you may have to impute interest income, and your family member may have to impute interest expense.
Chapter 5: Taxes
What Taxes Can You Deduct?
You can deduct various federal, state, local, and foreign taxes that are directly attributable to your trade or business.
For example, you can deduct state and local sales taxes that you pay on business supplies.
When Can You Deduct Taxes?
Generally, you can only deduct taxes in the year you pay them. For example, if you pay your bakery's property taxes in October, you can deduct the taxes in October.
What Are The Rules For Deducting Real Estate Taxes?
Deductible real estate taxes are those levied for the general public welfare. You can't deduct taxes for local benefits that increase the value of your property.
For example, you can deduct your bakery's general property taxes, but you can't deduct special assessments for street improvements.
What Are The Rules For Deducting Income Taxes?
Corporations and partnerships can deduct state and local income taxes. Individuals can deduct state and local income taxes as an itemized deduction on their personal income tax return.
For example, if your bakery is a sole proprietorship, you would deduct your state and local income taxes on Schedule A of your Form 1040.
What Are The Rules For Deducting Employment Taxes?
You can deduct the employer's share of Social Security, Medicare, and federal unemployment taxes. You can also deduct state unemployment taxes.
For example, if you pay $10,000 in wages to your employees, you can also deduct the employer's share of Social Security and Medicare taxes on those wages.
What Other Taxes Can You Deduct?
You can deduct other taxes, such as excise taxes, franchise taxes, fuel taxes, occupational taxes, personal property taxes, and sales taxes if they are incurred in the ordinary course of your business.
For example, if you pay a fuel tax on the gas you use to deliver baked goods, you can deduct that tax.
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Chapter 6: Insurance
What Insurance Premiums Are Deductible?
You can generally deduct premiums for insurance that covers business-related risks, such as fire, theft, liability, and workers' compensation.
For example, if you pay $5,000 per year for general liability insurance for your bakery, you can deduct that $5,000.
What Insurance Premiums Are Not Deductible?
You can't deduct premiums for personal insurance, such as life insurance or disability insurance.
For example, you can't deduct the premiums for your personal life insurance policy.
When Can You Deduct Insurance Premiums?
You can generally deduct insurance premiums in the tax year to which they apply.
For example, if you pay your bakery's liability insurance premiums in March for the following 12 months, you can deduct the portion that applies to the current tax year.
What Are The Rules For Deducting Insurance Premiums Under The Uniform Capitalization Rules?
You may have to capitalize insurance premiums under the uniform capitalization rules if you produce or acquire property for resale.
For example, if you purchase a new oven for your bakery, you would capitalize the insurance premiums on the oven as part of the cost of the oven.
Chapter 7: Costs You Can Deduct or Capitalize
What Are Carrying Charges?
Carrying charges are taxes and interest you pay to carry or develop real property or to carry, transport, or install personal property. You can choose to deduct or capitalize these charges.
For example, if you pay property taxes on land you're developing for a new bakery location, you can choose to deduct those taxes or capitalize them as part of the cost of the land.
What Are Research And Experimental Costs?
Research and experimental costs are those incurred for activities that eliminate uncertainty about the development or improvement of a product. These costs must be amortized over a 5-year period for domestic research or a 15-year period for foreign research.
For example, if you spend $100,000 on research to develop a new type of pastry for your bakery, you would amortize that cost over 5 years.
What Are Intangible Drilling Costs?
Intangible drilling costs (IDCs) are certain drilling and development costs for oil, gas, or geothermal wells in the United States. You can choose to deduct these costs currently or amortize them over 60 months.
For example, if you drill a well to produce geothermal energy to power your bakery, you can choose to deduct the IDCs immediately or amortize them over 5 years.
What Are Exploration Costs?
Exploration costs are those incurred to determine the existence, location, extent, or quality of any mineral deposit. You can choose to deduct these costs currently or capitalize them.
For example, if you hire a geologist to assess the potential for geothermal energy on your property, you can choose to deduct the geologist's fees or capitalize them as part of the cost of the geothermal deposit.
What Are Development Costs?
Development costs are those incurred to develop a mine or other natural deposit after the existence of commercially marketable quantities has been determined. You can choose to deduct these costs currently or capitalize them.
For example, if you spend money to develop a geothermal deposit after the geologist has confirmed its existence, you can choose to deduct the development costs or capitalize them as part of the cost of the geothermal deposit.
What Are Circulation Costs?
Circulation costs are those incurred to establish, maintain, or increase the circulation of a newspaper, magazine, or other periodical. You can choose to deduct these costs currently or capitalize them.
For example, if you own a bakery and you pay for advertising in a local magazine to promote your business, you can choose to deduct the advertising costs or capitalize them.
What Are Business Startup And Organizational Costs?
Business startup costs are those incurred before you begin operating your business, such as advertising, travel, and employee training.
Organizational costs are those incurred to create a corporation or partnership. You can choose to deduct a limited amount of these costs immediately and amortize the rest over 180 months.
What Are Reforestation Costs?
Reforestation costs are those incurred to plant or seed trees for forestation or reforestation. You can choose to deduct a limited amount of these costs immediately and amortize the rest over 84 months.
For example, if you own a bakery and you plant trees on your property to offset your carbon footprint, you can deduct a limited amount of the planting costs immediately and amortize the rest over 7 years.
What Are Retired Asset Removal Costs?
Retired asset removal costs are those incurred to remove a retired asset in connection with the installation or production of a replacement asset. You can deduct these costs.
For example, if you remove an old oven from your bakery to make room for a new one, you can deduct the removal costs.
What Are Barrier Removal Costs?
Barrier removal costs are those incurred to make a facility or public transportation vehicle more accessible to people with disabilities or the elderly. You can choose to deduct a limited amount of these costs immediately and capitalize the rest.
For example, if you install a ramp to make your bakery accessible to wheelchair users, you can deduct a limited amount of the ramp's cost immediately and depreciate the rest over its useful life.
What Are Film And Television Production Costs?
Film and television production costs are generally capital expenses. However, you can choose to deduct a limited amount of these costs if the production meets certain requirements.
For example, if you produce a commercial for your bakery, you may be able to deduct a limited amount of the production costs.
What Are Repair And Maintenance Costs?
Repair and maintenance costs are those incurred to keep your property in good working order. You can generally deduct these costs.
For example, if you pay to have your bakery's ovens cleaned and serviced, you can deduct those costs.
Chapter 8: Amortization
How Do You Deduct Amortization?
You deduct amortization by completing Part VI of Form 4562 and attaching it to your income tax return.
For example, if you're amortizing the cost of a lease, you would report the amortization deduction on Form 4562.
How Do You Amortize The Costs Of Starting A Business?
You amortize business startup and organizational costs over 180 months.
For example, if you have $10,000 in startup costs for your bakery, you would amortize those costs over 15 years.
How Do You Amortize The Costs Of Getting A Lease?
You amortize the costs of getting a lease over the term of the lease.
For example, if you pay $10,000 to take over a lease with 10 years remaining, you can deduct $1,000 per year for 10 years.
How Do You Amortize The Costs Of Section 197 Intangibles?
Section 197 intangibles are certain intangible assets, such as goodwill, going concern value, and patents. You amortize these costs over 15 years.
For example, if you buy a bakery and the purchase price includes $50,000 for goodwill, you would amortize that goodwill over 15 years.
How Do You Amortize Reforestation Costs?
You amortize reforestation costs over 84 months.
For example, if you have $10,000 in reforestation costs, you would amortize those costs over 7 years.
How Do You Amortize Geological And Geophysical Costs?
Geological and geophysical costs are those incurred in connection with oil and gas exploration or development. You amortize these costs over 24 months.
For example, if you spend $50,000 on geological surveys for oil and gas on your property, you would amortize that cost over 2 years.
How Do You Amortize Pollution Control Facilities?
You amortize the cost of a certified pollution control facility over 60 months.
For example, if you install a new air filtration system in your bakery, you would amortize the cost of the system over 5 years.
How Do You Amortize Research And Experimentation Costs?
You amortize research and experimentation costs over 5 years for domestic research or 15 years for foreign research.
For example, if you spend $100,000 on research to develop a new type of pastry for your bakery, you would amortize that cost over 5 years.
How Do You Amortize Certain Tax Preferences?
You can choose to amortize certain tax preference items over a specified period. For example, you can choose to amortize intangible drilling and development costs over 60 months.
Chapter 9: Depletion
Who Can Claim Depletion?
You can claim depletion if you have an economic interest in mineral property or standing timber. For example, if you own a bakery and you also own a timber farm, you can claim depletion on the timber you harvest from your farm.
What Is Mineral Property?
Mineral property includes oil and gas wells, mines, and other natural deposits. For example, a coal mine is a mineral property.
What Is Timber?
Timber is standing trees that you own or lease. For example, the trees on your timber farm are considered timber.
How Do You Figure Cost Depletion?
Cost depletion is based on the cost of the natural resource and the estimated total number of units that can be recovered. For example, if you buy a coal mine for $1 million and you estimate that you can recover 1 million tons of coal from the mine, your depletion unit is $1 per ton.
How Do You Figure Percentage Depletion?
Percentage depletion is based on a percentage of your gross income from the property. The percentage varies depending on the type of mineral. For example, the percentage depletion rate for coal is 10%.
What Are The Rules For Depletion Of Oil And Gas Wells?
There are special rules for the depletion of oil and gas wells. For example, there's a limit on the percentage of depletion you can claim for oil and gas wells.
What Are The Rules For Depletion Of Mines And Geothermal Deposits?
There are also special rules for the depletion of mines and geothermal deposits. For example, the percentage depletion rate for gold is 15%.
Chapter 10: Business Bad Debts
What Is A Business Bad Debt?
A business bad debt is a loss from the worthlessness of a debt that was created or acquired in your trade or business.
For example, if you sell baked goods to a customer on credit and the customer never pays you, you can claim a bad debt deduction for the amount owed.
When Does A Debt Become Worthless?
A debt becomes worthless when there's no longer any chance that you'll be able to collect the money owed.
For example, if you've tried to collect a debt from a customer but they've gone bankrupt, the debt is considered worthless.
How Do You Claim A Business Bad Debt?
You claim a business bad debt by using the specific charge-off method. This means you must charge off the debt on your books and records.
For example, if you determine that a customer's debt is worthless, you would write off the debt in your accounting records.
What Happens If You Recover A Bad Debt?
If you recover a bad debt you previously deducted, you must include the recovered amount in your income.
For example, if you wrote off a customer's debt in a previous year and they unexpectedly pay you, you must include the payment in your income.
Chapter 11: Other Expenses
What Are Some Other Miscellaneous Expenses That Can Be Deducted?
Other miscellaneous expenses that you can deduct include advertising expenses, legal and professional fees, and office expenses.
For example, you can deduct the cost of advertising your bakery in a local newspaper.
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What Expenses Are Not Deductible?
Expenses that are not deductible include personal expenses, entertainment expenses, and political contributions.
For example, you can't deduct the cost of your personal car or the cost of taking your family to a movie.
Chapter 12: How to Get Tax Help
What Resources Are Available To Help Businesses With Their Taxes?
The IRS offers a variety of resources to help businesses with their taxes, including publications, forms, instructions, and online tools. You can also get help from a tax professional.
For example, you can find information about deducting business expenses on the IRS website or in Publication 535.
How Fyle Automates Expense Tracking and Categorization to Make Tax Season a Breeze
Managing business expenses can be a time-consuming and tedious process, but Fyle can help automate it and make your life easier. Fyle is an expense management software that offers a variety of features to help you track and categorize your expenses.
- Real-time Credit Card Feeds: Fyle connects directly with all major credit card networks to bring you transaction data in real time. This means you don't have to wait for your credit card statement to track your expenses.
- Receipt Collection via Text Message: Fyle allows employees to submit receipts via text message and other everyday apps like Gmail, Slack, Outlook, etc, making it easy to keep track of your expenses and ensuring you have proper documentation for deductions.
- Automated Credit Card Reconciliations: Fyle automatically reconciles your credit card transactions with your receipts, which saves you time and reduces the risk of errors.
- Real-time Spend Visibility: Fyle provides a real-time view of all your expenses so you can see where your money is going and identify areas where you can save.
- Project Spend Tracking: Fyle allows you to track expenses by project so you can see how much you're spending on each project and stay within budget.
- Compliance: Fyle helps you comply with IRS regulations by ensuring that you have proper documentation for all your expenses.
In Conclusion
Understanding IRS Publication 535 is crucial for small and medium-sized business owners to maximize their tax deductions and minimize their tax liability.
By familiarizing yourself with the key takeaways from each chapter, you can make informed decisions about your business expenses and ensure you're following the IRS guidelines.
And don't forget, Fyle can help automate your expense tracking and categorization, making the process easier and more efficient.
Check out Fyle today to see how it can help you track your business expenses!
