IRS Publication 535: Business Expenses
Business expenses are the lifeblood of every successful enterprise — and the cornerstone of every IRS audit examination. Publication 535 defines what qualifies as a deductible expense, how to distinguish current expenses from capital investments, and the critical at-risk and passive activity rules that govern how much of your losses the IRS will allow. Whether you file Schedule C, operate a partnership, or run an S-corp, this guide is required reading before claiming any business deduction.
Common Deductible Business Expenses
Publication 535 organizes deductible business expenses into specific categories. Each category has its own rules, documentation requirements, and limitations. Here are the major expense categories every business owner should understand before filing.
Advertising & Marketing
All reasonable advertising costs are deductible — print, digital, billboards, direct mail, website development, SEO services, promotional materials, business cards, and sponsorships. Even goodwill advertising that keeps your business name before the public qualifies. Deduct in the year incurred.
Bad Debts
Business bad debts are deductible when a specific debt becomes partially or completely worthless. You must have previously included the amount in income (accrual method) to deduct it. Cash-method taxpayers generally cannot claim bad debt deductions because they never recognized the unpaid income.
Car & Truck Expenses
Deduct using either the standard mileage rate (67 cents per mile for 2024) or actual expenses (gas, repairs, insurance, depreciation, lease payments). Must maintain a contemporaneous mileage log with date, miles, destination, and business purpose. Commuting between home and your regular workplace is NOT deductible.
Depreciation & Section 179
Capital assets with a useful life exceeding one year must be depreciated. Section 179 allows immediate expensing of up to $1,220,000 (2024 limit, with $3,050,000 phase-out threshold) of qualifying property including machinery, equipment, vehicles, and certain building improvements. Bonus depreciation adds an additional first-year deduction.
Employee Compensation
Salaries, wages, bonuses, commissions, and fringe benefits are deductible if they are reasonable for the services performed and actually paid. Compensation to owners must be reasonable — excessive compensation to shareholder-employees may be reclassified as nondeductible dividends. Payroll taxes are separately deductible.
Insurance Premiums
Business insurance premiums are fully deductible: general liability, professional liability (malpractice/E&O), workers' compensation, property insurance, business interruption, commercial auto, cyber liability, and business overhead insurance. Health insurance for self-employed individuals and their families is deducted on the personal return (above the line), not as a business expense.
Interest Expense
Business interest expense is generally deductible, but IRC Section 163(j) limits business interest deductions to 30% of adjusted taxable income (ATI) for larger businesses. Interest on personal loans used for business purposes is deductible to the extent the funds are traceable to business use. Investment interest has separate limitations.
Legal & Professional Fees
Attorney fees, accountant fees, tax preparation for business returns, consulting fees, and professional service costs are fully deductible if ordinary and necessary to your business. Legal fees for business startup, asset purchases, or defending business property titles must be capitalized. Fees related to personal matters are not deductible.
Office Expenses & Supplies
Office rent, supplies, equipment, postage, printing, software subscriptions, cloud services, business telephone, internet access, and small tools are deductible in the year incurred. De minimis safe harbor allows expensing items costing $2,500 or less per invoice or item if you have an applicable financial statement (or $5,000 with an AFS).
Rent Expense
Rent paid for business property — office space, retail storefront, warehouse, equipment, vehicles — is deductible if it is reasonable and for property used in your trade or business. Lease payments that are structured to build equity (capital leases) may need to be treated as asset purchases rather than rent expense.
Repairs & Maintenance
Routine repairs that keep property in ordinary efficient operating condition are deductible in the year incurred. Improvements that materially increase the value, prolong the useful life, or adapt property to a new use must be capitalized and depreciated. The IRS safe harbor rules provide bright-line tests for distinguishing repairs from improvements.
Taxes & Licenses
State and local business taxes, real estate taxes on business property, personal property taxes on business assets, sales taxes on business purchases, employer payroll taxes (FICA, FUTA), business license fees, regulatory fees, and occupational taxes are deductible. Federal income tax is NOT deductible. State income tax is deducted on Schedule A, not as a business expense.
Travel, Meals & Entertainment
Business travel expenses (airfare, lodging, transportation, laundry, tips) are fully deductible when traveling away from your tax home for business. Meals are generally 50% deductible (80% for certain transportation worker meals). Entertainment expenses are NO LONGER deductible under current law. Recordkeeping must include amount, time, place, business purpose, and business relationship.
Utilities
Electricity, gas, water, sewer, trash collection, heating fuel, and telephone service used for your business are deductible. If you operate from a home office, utilities are deductible based on the business-use percentage of your home (see Publication 587 for home office deduction rules).
Home Office Deduction
If you use part of your home exclusively and regularly as your principal place of business, you may deduct a portion of mortgage interest, property taxes, utilities, insurance, repairs, and depreciation. The simplified method allows $5 per square foot up to 300 square feet ($1,500 maximum). The regular method requires detailed allocation.
Expenses That Are NOT Deductible
Personal Expenses
Any expense that is primarily personal in nature is not deductible. If an expense has both business and personal elements, you must allocate it and only deduct the business portion. Personal living expenses, family expenses, and household costs are never deductible.
Capital Expenses
Costs that provide a lasting benefit beyond the current tax year — buildings, equipment, machinery, vehicles, leasehold improvements, business startup costs — must be capitalized and depreciated, not deducted all at once. However, Section 179 and bonus depreciation provide immediate write-offs for many capital purchases.
Political Contributions & Lobbying
Contributions to political candidates, parties, PACs, and campaign committees are never deductible as business expenses. Lobbying expenses to influence federal or state legislation are generally not deductible, though certain local legislation lobbying and de minimis in-house lobbying may qualify.
Fines, Penalties & Illegal Payments
Fines and penalties paid to any government for violation of any law are not deductible. Bribes, kickbacks, illegal payments to government officials, and other unlawful business payments are strictly nondeductible. This includes parking tickets, regulatory fines, and penalties for late tax payments.
Club Dues
Dues paid to country clubs, social clubs, athletic clubs, airline clubs, hotel clubs, and other clubs organized for business, pleasure, recreation, or social purposes are generally NOT deductible. Professional association dues and trade organization dues remain deductible.
Commuting Expenses
The cost of driving between your home and your regular place of business is personal commuting and is not deductible. Transportation between two business locations, from your office to a client meeting, or from your home office to a business appointment is deductible business mileage.
Cost of Goods Sold (COGS) — For Manufacturers & Retailers
If your business produces, purchases, or sells goods, you must account for the cost of goods sold. COGS is not a "deduction" in the traditional sense — it is subtracted from gross receipts to determine gross profit before deducting business expenses.
Beginning Inventory
The value of inventory on hand at the start of the tax year. Must match the prior year's ending inventory. Errors in inventory valuation compound across years — the IRS scrutinizes inconsistencies carefully.
Purchases & Production Costs
Cost of raw materials, finished goods purchased for resale, direct labor, factory overhead, freight-in, and customs duties. For manufacturers, this includes all direct and indirect production costs allocated under the uniform capitalization (UNICAP) rules of IRC Section 263A.
Ending Inventory Valuation
Subtract ending inventory from goods available for sale to arrive at COGS. Inventory must be valued at the lower of cost or market. Acceptable methods include FIFO, LIFO, specific identification, and weighted average. LIFO requires IRS approval via Form 970.
At-Risk Rules & Passive Activity Loss Limits
Even if an expense is otherwise deductible, two powerful sets of rules can limit how much of your business losses the IRS will allow against your other income. These rules are complex and failure to apply them correctly is a frequent cause of IRS audit adjustments.
At-Risk Rules (IRC §465)
Your deductible loss is capped at the amount you have at risk — cash and property contributed to the activity, plus debt for which you are personally liable. Nonrecourse loans (where the lender's only recourse is the property itself) do not increase your at-risk amount. Losses disallowed under at-risk rules carry forward to future years.
Passive Activity Loss Rules (IRC §469)
Losses from passive activities — trade or business activities in which you do not materially participate — can only offset passive income, not wages, interest, dividends, or active business income. Material participation requires 500+ hours per year (or meeting one of six alternative tests). Rental real estate is per se passive unless you qualify as a real estate professional.
Material Participation Tests
Seven tests determine material participation: (1) 500+ hours in the activity; (2) substantially all participation is yours; (3) 100+ hours and no one else participates more; (4) significant participation activities (100-500 hours each) aggregating 500+ hours; (5) material participation in any 5 of the last 10 years; (6) material participation in any 3 prior years for personal service activities; (7) facts and circumstances show regular, continuous, substantial involvement.
$25,000 Rental Real Estate Exception
If you actively participate in rental real estate, you may deduct up to $25,000 of passive losses against non-passive income. This exception phases out by 50 cents for every dollar of modified adjusted gross income above $100,000 and is fully eliminated at $150,000 MAGI. Active participation is a lower bar than material participation but still requires involvement in management decisions.
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Business expense audits are among the most complex and high-stakes examinations the IRS conducts. Our CPA-led team understands Publication 535 inside and out — and we know exactly what the IRS looks for. From Schedule C deductions to partnership and S-corp expense allocations, we build bulletproof documentation and negotiate aggressively to preserve every legitimate deduction. Don't face a business audit alone.