Business vs. Personal Expenses

As a general principal, amounts that you spend for personal or family reasons are not deductible business expenses.

In many instances this distinction may be difficult to make, especially if yours is a family business or you work out of your home. However, the IRS has been known to come down hard on those who don't keep their personal and business expenses separate, and who attempt to deduct personal living expenses from business income.

Example A builder was not allowed a business deduction for expenses incurred as a result of his polo playing because he could not show a relationship between those expenses and a true business purpose.

The tax laws contain numerous very specific rules in areas where business expenses are difficult to disentangle from personal expenses. For example, commuting expenses are nondeductible, there are very specific rules on deducting business meals and entertainment, and certain types of property that are commonly used for recreation or amusement are subject to special depreciation rules and more stringent reporting. These rules are discussed in detail in later parts of this chapter.

If an expense is used partly for business and partly for personal purposes, you need to allocate the expense and deduct only the portion that pertains to business usage. The method of allocation depends on the nature of the expense. It can be done on the basis of time, space, usage or some other reasonable method.

Example If you have an employee who cleans your office and also cleans your house, you can deduct the portion of the employee's wages and payroll taxes that compensate for the hours spent cleaning the office, but not the home. If you drive your car for both business and personal purposes, you must allocate your car expenses on the basis of the mileage driven for business purposes, as opposed to that for personal or commuting purposes.

As a rough rule of thumb, if you're in doubt about whether a particular expense qualifies as a business expense rather than a personal one, ask yourself whether you would still have to pay the expense if you had the same income level but didn't work (perhaps all those direct-mail sweepstakes entries finally paid off).

If so, there's a good chance that what you have is a personal expense, not a business expense.

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