IRC Section 162: Ordinary and Necessary Business Expenses

Under Section 162 of the Internal Revenue Code, you can deduct ordinary and necessary business expenses paid or incurred during the tax year in carrying on a trade or business.¹ “Ordinary” means common and accepted in your industry. “Necessary” means helpful and appropriate to your business. Both bars are lower than they sound, but the expense still has to connect to a real business, fit the tax year, and survive several specific disallowances that override the general rule.

The Four Conditions Every Deduction Must Meet

Section 162(a) builds four requirements into a single sentence. Miss any one and the deduction fails, regardless of how legitimate the cost feels.

You Must Be Carrying On a Trade or Business

The activity has to be a genuine business, pursued in good faith for profit, with enough continuity to look like a real operation rather than a hobby. Managing your personal investments or selling one item on eBay a year doesn’t qualify. The IRS looks at whether you keep records, adjust your methods to improve profitability, and put real time into the work.

If a side venture generates losses year after year with no realistic path to profit, the IRS can reclassify it as a hobby, which wipes out the associated deductions entirely.

Ordinary

An ordinary expense is common and accepted in your particular field. It doesn’t need to be frequent or recurring. A construction firm buying liability insurance is ordinary. A bakery hiring a food safety consultant after a bad health inspection is ordinary. The question is whether other businesses in the same line of work routinely incur the same type of cost.

Necessary

A necessary expense is one that’s helpful and appropriate to running your business. It doesn’t have to be essential for survival. If a reasonable business owner in your position would spend the money to advance the business, it clears the bar. A landscaping company buying branded uniforms for its crew passes easily, even though the company could operate without them.

Paid or Incurred During the Tax Year

Timing depends on your accounting method. Cash-basis taxpayers deduct when they actually pay. Accrual-basis taxpayers deduct when all events creating the liability have occurred and the amount can be determined with reasonable accuracy, regardless of when cash changes hands.²

When You Have to Capitalize Instead of Deduct

Clearing the Section 162 tests doesn’t guarantee an immediate write-off. Section 263 requires costs that create an asset or produce a benefit lasting well beyond the current year to be capitalized and recovered over time through depreciation, amortization, or depletion.³

The practical line comes down to what the spending accomplishes. Replacing a broken window is a repair and is deductible in full. Replacing an entire roof with upgraded materials that extend the building’s useful life is an improvement and must be capitalized. If the work adds value, substantially extends an asset’s life, or adapts it to a different use, it’s a capital expenditure.⁴ Tangible business property is generally depreciated under the Modified Accelerated Cost Recovery System (MACRS), with recovery periods ranging from five years for computers to 39 years for commercial buildings.⁵

Three elections can pull capitalized costs back into current-year deductions.

The De Minimis Safe Harbor

The de minimis safe harbor lets you expense small purchases immediately. Businesses with an applicable financial statement (an audited statement, an SEC filing, or similar) can deduct items costing up to $5,000 per item or invoice. Everyone else, which covers most small businesses, uses a $2,500 threshold.⁶ You have to make the election every year by attaching a statement to a timely filed return.

Section 179 Expensing

Section 179 lets you deduct the full cost of qualifying business property in the year you place it in service. For 2026, the maximum deduction is $2,560,000, phasing out dollar-for-dollar once total equipment purchases exceed $4,090,000. Qualifying property includes machinery, equipment, off-the-shelf software, and certain improvements to nonresidential buildings like HVAC systems and roofing.

Bonus Depreciation

Bonus depreciation under Section 168(k) was on a phase-down schedule under the TCJA, dropping 20 points a year starting in 2023 and heading to zero in 2027. The One, Big, Beautiful Bill Act restored it to 100%. Unlike Section 179, bonus depreciation has no dollar cap, which makes it the primary tool for large asset purchases.

Common Deductible Categories and Their Quirks

The categories below are where most businesses spend most of their money. Each layers additional rules on top of the general Section 162 standard.

Compensation and Professional Fees

Wages, salaries, bonuses, and other compensation are deductible when reasonable for the work actually performed.¹ Closely held businesses run into trouble here when an owner-employee sets their own pay. The IRS compares that compensation against what similar businesses pay for similar work, factoring in qualifications, hours, and company revenue. Pay deemed excessive gets recharacterized as a non-deductible dividend.

Fees paid to lawyers, accountants, consultants, and bookkeepers for ongoing operations are deductible. The exception: professional fees tied to acquiring or selling a capital asset get capitalized as part of the transaction cost rather than deducted immediately.

Business Travel

Travel is deductible when you’re away from your tax home overnight or long enough to require sleep or rest. Your tax home is generally the city or area of your main place of business, not where you live. Deductible costs include airfare, train tickets, car rentals, lodging, and incidentals like tips and dry cleaning.

If you drive your own vehicle for business, you can use either the standard mileage rate or actual expenses (gas, insurance, depreciation, maintenance) for the business portion. The 2026 standard rate is $0.725 per mile.⁷ Lodging for a spouse or family member who tags along without a business purpose is not deductible.

Business Meals

You can deduct 50% of the cost of business meals. The meal can’t be lavish or extravagant, and you or an employee must be present when the food is served. The temporary 100% deduction for restaurant meals expired at the end of 2022. Workers subject to Department of Transportation hours-of-service rules, such as long-haul truckers, get an 80% limit for meals consumed on duty.⁸

Meals get audited often. For each one, record the amount, date, location, business purpose, and business relationship of each person present. Without that, the IRS can disallow the whole deduction.

Rent, Utilities, and the Home Office

Rent on office space, warehouses, retail locations, or leased equipment is fully deductible, provided you aren’t building equity or taking title through the payments. Utilities used for business are fully deductible.

If you work from home, only the portion allocated to a dedicated workspace qualifies. The regular method on Form 8829 requires calculating the percentage of your home used exclusively and regularly for business.⁹ The simplified method lets you deduct $5 per square foot, capped at 300 square feet ($1,500).¹⁰ The simplified method cuts paperwork but usually produces a smaller deduction for larger workspaces.

Insurance Premiums

Premiums for general liability, professional liability, property, workers’ compensation, and commercial auto insurance are deductible. Self-employed individuals can also deduct health insurance premiums (medical, dental, vision, and qualifying long-term care) for themselves, their spouse, and dependents. That deduction is taken on your personal return as an adjustment to income, not on Schedule C, and the plan must be established under your business.¹¹

One trap: you can’t deduct the self-employed health insurance premium for any month you were eligible to participate in an employer-subsidized health plan through your own employer, your spouse’s employer, or a dependent’s employer, even if you never enrolled.¹¹

Life insurance premiums are not deductible when the business is directly or indirectly the beneficiary. Key-person life insurance produces tax-free proceeds when it pays out, but you fund the premiums with after-tax dollars.¹²

Advertising and Marketing

Print ads, online advertising, social media campaigns, SEO services, direct mail, signage, and promotional materials are all deductible current expenses. Website hosting and maintenance are treated the same way. Initial website development sits in a gray area: some practitioners capitalize it like software and amortize over three years; others expense it under Section 179.

Education and Training

Education expenses are deductible when the training maintains or improves skills you already use, or when your employer or a licensing authority requires it to keep your job or professional standing.¹³ A CPA taking continuing education, a real estate agent attending a negotiation seminar, a nurse completing required recertification — all deductible.

Education that qualifies you for a new trade or business is not deductible, even if it looks related. A dentist going to medical school can’t deduct tuition. A marketing employee pursuing an MBA might, depending on whether the degree qualifies them for a fundamentally different career or just sharpens existing skills. The regulations treat a change in duties within the same general type of work as not creating a new trade or business.¹³

Start-Up and Organizational Costs

Expenses incurred before the business opens — market research, pre-opening training, scouting locations, lining up suppliers — are start-up costs under Section 195. They meet the ordinary and necessary test but fail the “carrying on” requirement because the business doesn’t yet exist.

In the year your business begins, you can elect to deduct up to $5,000 of start-up costs immediately. That allowance shrinks dollar-for-dollar once total start-up costs exceed $50,000.¹⁴ Anything above the immediate deduction gets amortized over 180 months starting the month the business opens.¹⁵ Corporations get a parallel rule under Section 248 for organizational costs like incorporation fees and formation expenses, with the same $5,000 immediate deduction and 180-month amortization structure.¹⁶

Bad Debts

Section 166 allows a full deduction for business debts that become completely worthless during the tax year. Partially uncollectible debts can be deducted only to the extent charged off, and only with IRS approval.¹⁷ The debt must have been created in connection with your trade or business. A personal loan to a friend that goes bad is a nonbusiness bad debt and gets less favorable treatment as a short-term capital loss.

Business Interest

Interest on loans used for business — lines of credit, equipment loans, commercial mortgages — is generally deductible under Section 163. Section 163(j) caps the deduction for larger businesses at 30% of adjusted taxable income, plus business interest income and floor plan financing interest. Small businesses are exempt if their average annual gross receipts over the prior three years fall below the inflation-adjusted threshold, which was $31 million for 2025.¹⁸ Most small businesses clear this comfortably and can deduct business interest without limitation.

What You Cannot Deduct

Several categories are blocked outright, regardless of how ordinary or necessary they appear.

Personal Expenses

Section 262 prohibits deducting personal, living, or family expenses.¹⁹ Your commute from home to your regular workplace, groceries, and ordinary clothing stay personal even when work drives them. A business suit isn’t deductible because you could wear it to a wedding. Uniforms or specialized protective gear not suitable for street wear can qualify, but the bar is high.

Entertainment

Since the Tax Cuts and Jobs Act took effect in 2018, business entertainment is completely non-deductible. Taking a client to a sporting event, a concert, or a golf outing produces no deduction. Dues for any club organized for business, social, or recreational purposes are also non-deductible. Narrow exceptions remain for recreational events primarily for non-highly-compensated employees (a company holiday party, for example), goods made available to the general public, and expenses treated as taxable compensation to the recipient.²⁰ If you buy a client dinner at an entertainment event, you can still deduct 50% of the meal, but only if the food is purchased separately or itemized on a separate invoice.

Fines and Penalties

Section 162(f) bars deductions for fines, penalties, and similar amounts paid to a government for violating any law, civil or criminal. Traffic tickets, OSHA penalties, environmental fines, and tax-related penalties all qualify. Restitution or remediation payments can still be deductible, but only when the court order or settlement agreement specifically identifies the payment as restitution, remediation, or an amount paid to come into compliance with a law.²¹ A vague settlement that lumps everything together won’t preserve the deduction, so getting the restitution language right in the agreement itself matters.

Lobbying and Political Contributions

Section 162(e) blocks deductions for expenses tied to influencing legislation, participating in political campaigns, attempting to sway the public on legislative matters, or communicating with executive branch officials to influence their official positions. Contributions to candidates, parties, and PACs are also non-deductible. A small exception covers in-house lobbying expenditures that don’t exceed $2,000 per year, excluding overhead.²² Monitoring legislation without actively trying to influence outcomes is also permitted.

Business Gifts Over $25

You can deduct the cost of gifts to clients or business contacts, but only up to $25 per recipient per year.²³ That cap hasn’t been adjusted for inflation since it was enacted. Incidental items costing $4 or less with your company name permanently imprinted (pens, notepads, keychains) don’t count toward the limit. Promotional materials like display racks used on the recipient’s business premises are also excluded.

Records That Keep the Deduction

No deduction survives an audit without documentation. The IRS requires records supporting every item of income and deduction for as long as they may be relevant, which generally means at least three years after filing. If you underreport gross income by more than 25%, the window extends to six years. For fraudulent or unfiled returns, there is no time limit.²⁴

Travel, meals, and gifts face heightened substantiation under Section 274(d). You must document the amount, the time and place, the business purpose, and the business relationship of the people involved.²⁵ A credit card statement for an $85 restaurant charge isn’t enough on its own. You need a contemporaneous note explaining who was there and what business was discussed. Reconstructing records from memory months later tends to fall apart under examination.

Digital records are acceptable. Electronic storage systems work as long as they accurately reproduce the originals and let you retrieve specific records on request. Hold on to records for depreciable assets until the statute of limitations expires for the year you dispose of the property, since the original cost basis stays relevant the entire time you own it.²⁴

1
Office of the Law Revision Counsel. 26 USC 162: Trade or Business Expenses
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eCFR. 26 CFR 1.162-1 – Business Expenses
3
Office of the Law Revision Counsel. 26 USC 263: Capital Expenditures
4
eCFR. 26 CFR 1.263(a)-1 – Capital Expenditures; In General
5
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
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Internal Revenue Service. Notice 2015-82: Increase in De Minimis Safe Harbor Limit
7
IRS. 2026 Standard Mileage Rates
8
Office of the Law Revision Counsel. 26 USC 274: Disallowance of Certain Entertainment, Etc., Expenses – Section 274(n)(3)
9
Internal Revenue Service. Instructions for Form 8829 (2025)
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Internal Revenue Service. Simplified Option for Home Office Deduction
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Internal Revenue Service. Instructions for Form 7206
12
eCFR. 26 CFR 1.264-1 – Premiums on Life Insurance Taken Out in a Trade or Business
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eCFR. 26 CFR 1.162-5 – Expenses for Education
14
Office of the Law Revision Counsel. 26 USC 195: Start-Up Expenditures
15
eCFR. 26 CFR 1.195-1 Election to Amortize Start-Up Expenditures
16
Office of the Law Revision Counsel. 26 U.S. Code 248 – Organizational Expenditures
17
Office of the Law Revision Counsel. 26 U.S. Code 166 – Bad Debts
18
Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
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Office of the Law Revision Counsel. 26 USC 262 – Personal, Living, and Family Expenses
20
Office of the Law Revision Counsel. 26 USC 274: Disallowance of Certain Entertainment, Etc., Expenses – Section 274(e)
21
Federal Register. Denial of Deduction for Certain Fines, Penalties, and Other Amounts; Related Information Reporting
22
Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses – Section 162(e)(4)(B)
23
Office of the Law Revision Counsel. 26 USC 274: Disallowance of Certain Entertainment, Etc., Expenses – Section 274(b)
24
Internal Revenue Service. Publication 583 Starting a Business and Keeping Records
25
Office of the Law Revision Counsel. 26 USC 274: Disallowance of Certain Entertainment, Etc., Expenses – Section 274(d)