How To LEGALLY Maximize Tax Write-Offs | IRS Codes Revealed 🤯

In today’s blog, we will be discussing the importance of understanding what qualifies as a business deduction, as the IRS looks at specific codes and regulations. As a business owner, you need to be aware of one tax code, which has four sections, to ensure that every expense in your business qualifies for deductions. 

And by the end of this blog, you will be able to identify the expenses in your business that you can maximize to pay less money to the IRS and grow your business. The code that we will be focusing on is Code Section 162 A, which is the foundation of how the IRS looks at businesses.

It is crucial to understand that everything the IRS considers is laid out in their codes. That is why understanding Code Section 162 A is key to maximizing almost every single tax deduction related to your current or potential business.

In this video, we will be reading directly from the IRS Code Section 162 A and breaking down each part so you can understand it. Don’t be intimidated by the thought of reading codes or regulations – we will simplify it for you and only include the relevant information to help you maximize your tax deductions.

What is Code Section 162A?

Code Section 162A deals with trade or business expenses. It is important to note that as a business owner, you have the advantage of being able to deduct expenses from your taxable income, which is a privilege not extended to W-2 employees with limited deductions.

This is why we often encourage clients to have some form of business or rental property as it qualifies for deductible expenses that can lower your taxable income. Speaking of lowering taxable income, we will also touch on the difference between the effective tax rate and the standard tax rate.

As a W-2 employee, you may be in a high standard tax rate, leading to a higher effective tax rate due to limited strategies to deduct from your W-2 income. On the other hand, being a business owner provides more flexibility and can bring down your effective tax rate. For those unfamiliar with the term, the effective tax rate refers to the taxes you actually owe compared to the standard tax rate set by the government based on your bracket. 

Now, let’s get into the specifics of Code Section 162A, which is titled “Trade or Business Expenses“.

Specifics of Code Section 162A

This code section allows for the deduction of expenses incurred during the course of conducting a business. It’s important to note that this is a privilege not available to W-2 employees, who have very limited deductions available to lower their taxable income.

One of the benefits of being a business owner is the ability to bring down your effective tax rate, which is the amount of taxes you actually owe, compared to the standard tax rate set by the government. Understanding this concept is crucial if you want to take advantage of the deductions available to business owners.

The code section 162 A is clear about what constitutes a trade or business. To qualify for deductions, the expenses must be ordinary, necessary, and incurred during the course of conducting a business with the intention of making a profit. Expenses not related to the business will be considered non-deductible.

A trade or business is any activity that we undertake with the intention of making a profit. This can range from providing a service or selling a product. It is essential to have a clear understanding of the business purpose in order to determine if expenses incurred are business-related and therefore deductible.

For instance, let’s take real estate investing as an example. If the business purpose is to own long-term rental properties, then the expenses incurred should be related to the real estate industry. If not, then the expenses may be considered nondeductible. However, if the business owner wants to consider deducting expenses for items like medical equipment, they could consider opening a separate business in the medical field. This allows for a clear separation of businesses and provides more evidence to support deductions.

It is crucial to maintain a clear distinction between different businesses and to ensure that expenses are only incurred for related businesses. This makes it easier to provide support for the deductions and helps to avoid confusion between different types of businesses. Moving forward, let’s take a closer look at the word “ordinary” in the code section 162 A.

What Does It Mean By Ordinary and Necessary?

The term “ordinary” refers to expenses incurred in the regular course of conducting business. For instance, if you are a real estate investor, driving around town to inspect properties can be considered an ordinary expense. On the other hand, if you have a home-based business that does not require you to use a vehicle, it would be harder to claim auto deductions.

To maximize deductions, it’s important for business owners to consider all the necessary activities that contribute to business growth, such as networking and meeting with clients and business partners. These activities can also be considered deductible expenses, even if they are not part of the daily routine of the business.

Lastly, we come to the term “necessary”. For expenses to be considered deductible, they must be necessary for the business to be profitable. This means that any expense incurred for the purpose of growing the business can be considered necessary. In other words, the expenses must be directly tied to the success and profitability of the business.

It is also important to remember that this term can vary depending on the industry and type of business. For businesses with unique models, having well-documented websites and marketing materials can help support what is considered necessary.

Having a good amount of documentation makes it easier to understand what expenses are considered ordinary and necessary. And now, before diving into the final point, let’s take a look at the last three tips from the IRS on this code section.

3 IRS Examples of Expenses That Are Deductible

The IRS is being generous by providing three examples of expenses that are deductible for a business, as long as they are ordinary, necessary, and conducted in the regular course of business.

1. Reasonable allowance for salaries or other compensation for services actually rendered

The first example is a reasonable allowance for salaries or other compensation for services actually rendered. This means that businesses can deduct salaries paid to employees rendering services for the business to be profitable. It’s important to note that the business owner’s salary is not the only salary that can be deducted.

The IRS allows for deducting expenses for meals and lodging, but it must be in the pursuit of a trade or business and not lavish or extravagant in nature.

2. Traveling Expenses

When considering traveling expenses, it’s important to define the parameters of your ordinary day, including your daily commute. Anything outside of your normal commute could be considered travel and eligible for deductions, including meals and lodging.

However, it’s crucial to keep in mind that these deductions must not be extravagant or lavish. Consider the market value when determining the amount you’re paying, and avoid paying more than 2 to 3 times the market value to avoid the IRS considering it lavish.

We also mentioned earlier that there are certain strategies for S corporations where you can take a salary and deduct it from your business while avoiding self-employment taxes, but we won’t be diving into that today.

One important aspect to consider is the profitability of your business and whether the expenses you’re looking to deduct are necessary or not. It’s important to keep up with the latest rules and regulations, especially when it comes to meals, as the limit for deductions is subject to change.

When it comes to traveling expenses, including meals and lodging, it’s crucial to understand the criteria for deducting them. To qualify, you must be away from home in pursuit of your trade or business and the expenses must not be considered lavish or extravagant under the circumstances. It’s important to keep in mind the market value of the expenses you’re incurring and whether they’re within reasonable limits.

3. Lodging Expenses

As for lodging expenses, it’s a good idea to consult with a CPA to understand the rules around deducting them. If you’re conducting business, you’re likely able to deduct travel, meals, and lodging on the days you’re conducting business, including the days you’re traveling to and from your destination.

Rental payments required for your business can also be deductible. This includes rent for your office space or the portion of your home that is used for your business if you run a home-based operation.

In conclusion, it’s important to make sure that your business deductions are related to your trade or business, ordinary, necessary, and not lavish or extravagant. Be sure to talk to your CPA to understand how you can maximize these deductions and regulations.