Ordinary and Necessary Expenses: IRS Tests, Limits, and Records

Ordinary and necessary business expenses are the day-to-day costs of running a trade or business that you can subtract from gross income under Section 162 of the Internal Revenue Code. An expense qualifies when it is both “ordinary” (common and accepted in your line of work) and “necessary” (helpful and appropriate for the business).¹ Both tests have to be met at the same time, and several large categories of spending come with their own limits layered on top.

The Two-Part Test

Ordinary means common and accepted in your particular industry.² It does not have to be recurring. A freelance photographer who replaces a stolen lens is incurring a cost other photographers would recognize as routine, even if it only happens once. The question is whether people in the same trade would look at the expense and say it makes sense.

Necessary means helpful and appropriate — a lower bar than most people expect. The expense does not need to be essential or indispensable. A second phone line dedicated to client calls is necessary even if you could technically use your personal phone.

Expenses that are common in your industry but serve no business purpose fail. Expenses that clearly help your business but are unheard-of in your trade also fail. Most routine operating costs clear both tests without argument; the fights happen where personal benefit and business use overlap.

Costs That Routinely Qualify

The categories the IRS sees most often are the ones that keep a business operating:

Wages, salaries, bonuses, and commissions paid to employees, as long as the amounts are reasonable for the services performed.¹
Rent for office space, equipment, warehouses, or other property used in the business.
Utilities — electricity, gas, water, internet, and phone at business locations.
Advertising, marketing, website costs, and promotional materials.
Insurance premiums for liability coverage, property insurance, and employee health plans.
Supplies consumed in normal operations, from printer paper to cleaning products.
Fees paid to accountants, attorneys, and consultants for business-related work.

The list is not exhaustive. Any legitimate cost of doing business can qualify if it clears the two-part test and you can document it.

Expenses With Special Limits

Several common categories carry caps or conditions that catch owners off guard.

Business Meals

Food and beverages tied to a business purpose are deductible at 50 percent of the cost.³ A temporary 100 percent deduction for restaurant meals expired at the end of 2022, and the 50 percent cap is back in full effect.⁴ You or an employee must be present at the meal, and the meal cannot be lavish or extravagant. Keep a record of who attended, the topic discussed, and the amount spent.

Entertainment

Entertainment is not deductible at all. Taking a client to a sporting event, concert, or golf course does not qualify, no matter how much business you discuss while you are there.³ Dues for social, athletic, or recreational clubs are also out. If you buy a meal at an entertainment event and the meal is invoiced separately, the meal portion can still qualify for the 50 percent deduction.

Vehicle Expenses

If you use a car, van, or truck for business, you can deduct vehicle costs under one of two methods. The standard mileage rate for 2026 is 72.5 cents per mile.⁵ The alternative is the actual expense method, where you track fuel, insurance, repairs, tires, registration, and depreciation, then deduct the business-use percentage.⁶

Timing matters. If you own the vehicle, you must choose the standard mileage rate in the first year the car is available for business; otherwise, you are locked into the actual expense method for that vehicle. If you lease, whichever method you pick applies for the entire lease period.⁵ Only the business portion counts. Commuting between home and your regular office does not.

Home Office

You can deduct expenses for the business use of your home only if the space is used exclusively and regularly as your principal place of business.⁷ A desk in a bedroom that also hosts overnight guests does not qualify. The regular method lets you figure actual expenses (mortgage interest, utilities, insurance, repairs) based on the percentage of your home used for business. The simplified method is $5 per square foot up to 300 square feet, capping the deduction at $1,500.⁸

Equipment Purchases

Equipment, furniture, software, and other tangible property normally have to be depreciated over several years. Section 179 lets you deduct the full purchase price in the year you place the asset in service, up to $2,560,000 for tax years beginning in 2026.⁹ That limit phases out dollar-for-dollar once total qualifying purchases exceed $4,090,000, and the deduction cannot exceed your taxable income from the active conduct of a trade or business; excess carries forward.

For smaller items, the de minimis safe harbor under the tangible property regulations lets you deduct property costing $2,500 or less per invoice ($5,000 if your business has audited financial statements).¹⁰ This is how most small businesses handle laptops, office chairs, and small tools without touching depreciation schedules.

Start-Up and Organizational Costs

Expenses before your business officially opens — market research, scouting locations, training employees, legal fees for forming an entity — are start-up costs. They do not get deducted the way ongoing operating expenses do. You can immediately deduct up to $5,000 in start-up costs in the year your business begins active operations. If total start-up costs exceed $50,000, that $5,000 allowance shrinks dollar-for-dollar and disappears entirely at $55,000.¹¹ Everything above the immediate deduction is amortized evenly over 180 months, starting the month you open.

Organizational costs — the fees for actually creating your business entity, including state filing fees and drafting partnership or operating agreements — follow the same structure: up to $5,000 deductible immediately, with the same $50,000 phase-out and 180-month amortization for the rest. A new business can potentially write off $10,000 of combined start-up and organizational costs in its first year.

What You Cannot Deduct

Some spending looks business-related but is barred by statute. Getting these wrong does not just cost you the deduction; it can draw penalties.

Personal, living, and family expenses are not deductible, even if you pay them from a business account.¹² Running groceries through a business credit card does not convert them. For mixed-use items like a cell phone, only the business percentage comes off.

Capital expenditures — costs that improve property, adapt it to a new use, or extend its useful life — cannot be deducted all at once. They are added to the asset’s basis and recovered through depreciation.¹³ Replacing a roof on your office building is capital; patching shingles is a deductible repair. The line between repairs and improvements is one of the most frequently litigated areas in business tax, so document your reasoning.¹⁰

Fines and penalties paid to a government or at a government’s direction because of a law violation, or an investigation into one, are non-deductible.¹⁴ This covers parking tickets through multimillion-dollar regulatory settlements. A narrow exception exists for amounts specifically identified in a court order or settlement agreement as restitution or compliance costs, but the taxpayer carries the burden of proof.

Lobbying and political spending is out. Costs of influencing legislation, participating in political campaigns, swaying public opinion on elections or referendums, or communicating with executive branch officials to influence their official actions are all non-deductible, as are the research and planning costs tied to those activities. A small exception for in-house lobbying under $2,000 per year exists but rarely matters in practice.

The Hobby-Loss Risk

If the IRS decides your activity is not engaged in for profit, you lose the ability to deduct expenses under Section 162 entirely.¹⁵ That matters for side ventures and creative pursuits that look a lot like hobbies.

There is a safe harbor. An activity that shows a profit in at least three of the last five consecutive tax years is presumed to be operated for profit. For breeding, training, showing, or racing horses, the test is two out of seven years.¹⁵ Missing the safe harbor does not automatically make an activity a hobby; it shifts the burden to you to show genuine profit motive.

The IRS weighs nine factors drawn from Treasury regulations when it looks at motive, including how businesslike your operations are, the time and effort you put in, your history of income and losses, whether you have sought expert advice, and whether the activity involves significant personal pleasure.¹⁶ No single factor decides the question. Persistent losses on an activity you clearly enjoy will draw scrutiny. Detailed books, a separate bank account, and a written business plan help your position.

What the IRS Expects You to Keep

The IRS does not take your word for a deduction. For every expense you claim, records should identify the payee, the amount, the date, and the business purpose. Receipts, invoices, canceled checks, credit card statements, and account records all count.¹⁷

Travel and meals face a higher standard. Record the amount, date, location, and the specific business purpose or the relationship of the people involved.¹⁸ “Client dinner” on a receipt is not enough. Write down who you met and what you discussed. Same-day beats April reconstruction.

Keep business tax records at least three years from the date you file the return. If you underreport income by more than 25 percent, the IRS has six years to audit. For deductions tied to worthless securities or bad debts, the retention period is seven years.¹⁹ When in doubt, keep everything. Storage is cheap. Reconstructing records in an audit is not.

1
Office of the Law Revision Counsel. 26 U.S. Code 162 – Trade or Business Expenses
2
Internal Revenue Service. Ordinary and Necessary Business Expenses
3
Office of the Law Revision Counsel. 26 USC 274 – Disallowance of Certain Entertainment, Etc., Expenses
4
Internal Revenue Service. About Business Travel Expenses
5
Internal Revenue Service. IRS Sets 2026 Business Standard Mileage Rate at 72.5 Cents Per Mile
6
Internal Revenue Service. Topic No. 510, Business Use of Car
7
Internal Revenue Service. Topic No. 509, Business Use of Home
8
Internal Revenue Service. Simplified Option for Home Office Deduction
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Office of the Law Revision Counsel. 26 USC 179 – Election to Expense Certain Depreciable Business Assets
10
Internal Revenue Service. Tangible Property Final Regulations
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eCFR. 26 CFR 1.195-1 – Election to Amortize Start-Up Expenditures
12
Internal Revenue Service. Income and Expenses
13
Internal Revenue Service. Topic No. 704, Depreciation
14
Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses
15
Office of the Law Revision Counsel. 26 USC 183 – Activities Not Engaged in for Profit
16
Internal Revenue Service. Activities Not Engaged in for Profit Audit Technique Guide
17
Internal Revenue Service. What Kind of Records Should I Keep
18
Internal Revenue Service. Publication 463 – Travel, Gift, and Car Expenses
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Internal Revenue Service. How Long Should I Keep Records