Can I deduct this?

Let's face it. If you're in business, there's always an expense. Payroll, travel, overhead, the list goes on and on (and on and on and on...). The question then becomes one of deductible expenses. The fact is, there is no fixed rule about what may or may not be deducted for business purposes. There are so many ways to make money, along with so many ways to spend it, that even the IRS has been forced to take this into account. As such, instead of a rule, the IRS uses a guideline.

" To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary."

So how does this work? Let's use the following for an example:

You've decided to open up a service business, serving the needs of the community by doing low-cost data entry. Business is good, and before you know it, the year has come to a close. You're looking at your Profit and Loss statement, reconciling bank and credit card statements, and trying to get everything ready for your accountant. There are only a few questions you have, but they could have a serious impact on your bottom line.

1. You had to purchase a couple of different computer programs to connect your office computer to your client's computer. These programs cost you $2,395.

2. You purchased a peripheral for your computer. You could have worked without it, but this peripheral cuts down on your time spent doing certain tasks by 15-20 minutes at least.

3. Your oldest client has updated their software. You don't need to update your software in order to do the work, but you decide to anyway.

4. A client tells you his computers were hacked during the year. No information was stolen, and he doesn't blame you. But as a result of this conversation, you run out and purchase multiple types of computer security programs and accessories even though the security you already have is more than sufficient for your needs.

Before going through this list of items, I need to give the standard, "Every situation is different and not all answers will be applicable to your situation, contact a professional, etc." So, let's look at these one at a time.

1. You had to purchase a couple of different computer programs to connect your office computer to your client's computer. These programs cost you $2,395.

Using the IRS guidelines, these purchases would be both ordinary and necessary, so yes, this would be a deduction. Furthermore, the IRS has established a Safe Harbor for deductions such as these. As long as the individual programs cost less than $2,500, then you don't have to capitalize or depreciate them. Rather, you can take the entire deduction at one time.

2. You purchased a peripheral for your computer. You could have worked without it, but this peripheral cuts down on your time spent doing certain tasks by 15-20 minutes at least.

Was this an ordinary expense? Probably. In an age of technology, most peripheral purchases would be considered ordinary unless they were specialized items (if they were specialized, there's an entirely different set of rules to follow, and we're not getting into them here). Was it necessary, though? Some would argue not. After all, you could do the work without it, right? But look at the definition of necessary. A necessary expense is one that is helpful and appropriate for your trade or business. The key words are helpful and appropriate. No one would argue against the peripheral being helpful, and as such, it was most definitely appropriate. Thus, this would be a legitimate deduction (we still need to consider the Safe Harbor mentioned above before expensing or depreciating the purchase, but you'll still get the deduction one way or the other).

3. Your oldest client has updated their software. You don't need to update your software in order to do the work, but you decide to anyway.

Ordinary? Yes, no real question about that. Necessary? That's where it becomes questionable. The update would be appropriate as such things go, but would it be helpful? A case could be made either way. I would most likely say yes, this is deductible, if for no other reason than updating your software to match the client's will cut down on the possibility of communication errors between systems as well as increase compatibility between computers.

4. A client tells you his computers were hacked during the year. No information was stolen, and he doesn't blame you. But as a result of this conversation you run out and purchase multiple types of computer security programs and accessories even though the security you already have is more than sufficient for your needs.

Hacking is a serious concern, and so is computer security. On the face of this, most people would immediately say this was deductible. We, however, are going to dig a little deeper. You already have security on your computers. Does it meet industry standards? Does it exceed them? And if so, by how much? What type of programs did you buy? What accessories? These are a few of the questions you should ask yourself (and an agent will ask as well). There's an old saying, "Don't use a cannon to kill a mosquito". As important as computer security is, like everything else, going overboard would neither be considered ordinary or necessary. You should always keep your industry in mind when making purchases. Depending on what you bought and what you're trying to protect, none of these purchases may be considered either ordinary or necessary.

Ordinary and necessary are key words for deductibility. Remember the disclaimer above? What's ordinary and necessary for one business may not be for another. Always keep YOUR business in mind when making a purchase and, for the most part, ordinary and necessary will guide you in the right direction. For everything else, well, that's what your accountant is for, right?