Ordinary and necessary expenses are business costs that can be deducted from revenue as part of determining taxable income. Accounting for these expenses can help business owners, including sole proprietors such as freelancers and gig workers, ultimately save money on taxes.
Definition and Examples of Ordinary and Necessary Expenses
As the name implies, ordinary and necessary expenses are defined by being ordinary and necessary for a business; if that’s the case, these expenses generally can be deducted for tax purposes.
More specifically, the Internal Revenue Service (IRS) defines ordinary expenses as those that are “common and accepted in your industry,” while necessary expenses are those that are “helpful and appropriate for your trade or business.”
Many types of ordinary and necessary business expenses can exist, such as advertising costs, office supplies, business insurance, and more.
However, some types of common expenses, like those that factor into the cost of goods sold, fall into different categories. And while many types of business expenses can be ordinary and necessary, the specifics can vary greatly among businesses.
“It's all relative. What’s ordinary and necessary for one business is not necessarily ordinary and necessary for another,” Michele Cagan, CPA, told The Balance by phone.
For example, Cagan noted that some business owners want to deduct dog food as an ordinary and necessary expense because they work from home with their pet or bring their dog to their office. But, generally, dog food would not be deductible, because it’s something that would be purchased personally, with or without the business existing.
That said, dog food might be deductible as an ordinary and necessary business expense for some pet-oriented businesses, she said, like a veterinarian who supplies treats for patients.
To be ordinary and necessary, “there has to be an obvious tie toward this expense trying to create income,” Cagan said. Keep in mind that an ordinary and necessary business expense does not have to successfully generate revenue, as long as there was reasonable intent to do so, she said, such as in the case of a marketing campaign that flops.
How Ordinary and Necessary Expenses Work
Ordinary and necessary expenses work by a business owner claiming these costs as deductions within their tax filings. For individual business owners, such as those who are sole proprietors—a category that can include freelancers and gig workers—ordinary and necessary business expenses are often claimed on Schedule C.
On this form, business owners with pass-through income, which means their business structure passes tax liabilities through to the personal returns of the owner, can report how much they spent within various categories, ranging from legal and professional services to deductible travel and meals. These expenses then offset the amount of revenue the business earned, which reduces taxable income. However, the reductions aren’t always equal to the full purchase cost.
For example, only 50% of the cost of business meals can generally be deducted. Plus, not all meals necessarily count as ordinary and necessary expenses. You can’t automatically deduct the cost of your daily lunch, for instance, just because you ate it at your desk, Cagan said.
“Business meals have to have a business purpose … such as by meeting with a customer … where you're furthering business [while] you're having a meal,” she says.
Some ordinary and business expenses might also be prorated based on the mix of professional versus personal usage, such as if you deduct the proportion of a phone bill used for work, rather than the full cost.
Also keep in mind that IRS forms might not specify whether something is an ordinary and necessary expense, but that doesn’t mean a business owner can’t claim the deduction, as long as they can justify it.
"Just because something isn’t a line item on a tax form doesn’t mean you shouldn’t take it,” Cagan said.
What Ordinary and Necessary Expenses Mean for Individuals
While ordinary and necessary expenses apply to business expenses, individuals may still want to understand this area if they have any income outside of their main employment. If you freelance, have a side hustle, or you’re thinking of starting your own business, it can be useful to know what’s tax-deductible.
Because ordinary and necessary expenses can be somewhat subjective, however, you may want to consult with a tax professional who can help you decide whether something should be claimed. Doing so can help you deduct ordinary and business expenses you may not have realized are eligible, and it can also help you avoid claiming expenses that could get you into trouble.
- Ordinary and necessary expenses meet the criteria of being something that a business has a legitimate reason for incurring.
- Some types of purchases may be ordinary and necessary for one business but not for another, depending on several factors.
- Individuals who have business income, such as freelancers and gig workers, can reduce their taxable income by claiming ordinary and necessary expenses.