When is a business expense "Ordinary & Necessary"?

If you run a small business, are self-employed, have a "side hustle", or are a gig worker, you have probably heard the term "ordinary and necessary" when it comes to your business expenses. This phrase comes directly out of the Internal Revenue Code §162(a): "There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business...". I want to point out that it is ordinary AND necessary - just because something is recurring it might be "ordinary" but not "necessary". Likewise, something might be "necessary", but no reasonable IRS agent would see it as "ordinary".

The discussion on what constitutes an ordinary and necessary expense is something that has been going on for a long time and won't die down anytime soon. There have been numerous Tax Court cases and private letter rulings talking about this subject. It has landed business owners in a world of trouble with the IRS because it is something that is subjective (or a gray area). For Example, self-employed individuals might start looking at how much they are paying in self-employment and income tax and start rationalizing expenses, like the aerial drone they bough that records video is actually an ordinary and necessary marketing expense for their housecleaning business.

There is no foolproof answer to what is "ordinary and necessary". As a former IRS agent, I can tell you that agents are taught to look at everything on a case by case basis - there is no one size fits all metric that is used.

For the business owners that self-prepare their return, if you are getting to the point where you are starting to have questions about if your business expenses are ordinary and necessary, it might be time to look at hiring a CPA to help with your tax and bookkeeping needs.

Send us an email or set up a time to meet ​here​ if you are interested in hearing about how Larson CPA can help your business with its bookkeeping and tax needs!