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What business expenses can you deduct under Tax Code 162?
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What Is IRC 162
IRC 162 refers to the Internal Revenue Code Section 162 entitled “Trade or Business Expenses”.
Section 162 IRC is a tax rule relating to the type of deductions companies can make for business expenses.
This provision is quite important for companies as they may rely on this provision to deduct expenses from the business earnings leading to tax savings for them.
For a business expense to be deductible, it must meet the requirements of Section 162.
On the other hand, if a business expense is not deductible, then it will be considered as a consumption expense.
Internal Revenue Code Section 162 Overview
The IRC Code Section 162 is composed of many articles dealing with a company’s trade or business expense.
Here is an overview of the structure of 26 USC 162:
- Section 162(a): Business expenses
- Section 162(a)(1): Salaries and other compensation
- Section 162(a)(2): Traveling expenses
- Section 162(a)(3): Rental expenses
- Section 162(b): Charitable contributions and gifts
- Section 162(c): Illegal bribes, kickbacks, and other payments
- Section 162(d): Capital contribution to Federal National Mortgage Association
- Section 162(e): Denial of deduction for certain lobbying and political expenditures
- Section 162(f): Fines, penalties, and other amounts
- Section 162(g): Treble damage payments under the antitrust laws
- Section 162(h): State legislators’ travel expenses away from home
- Section 162(i): Repealed
- Section 162(j): Certain foreign advertising expenses
- Section 162(k): Stock requisition expenses
- Section 162(l): Special rules for health insurance costs of self-employed individuals
- Section 162(m): Certain excessive employee remuneration
- Section 162(n): Special rule for certain group health plans
- Section 162(o): Treatment of certain expenses of rural mail carriers
- Section 162(p): Treatment of expenses of members of reserve component of Armed Forces of the United States
- Section 162(q): Payments related to sexual harassment and sexual abuse
- Section 162(r): Disallowance of FDIC premiums paid by certain large financial institutions
- Section 162(s): Cross references
Section 162(a) Requirements
For a business expense to be deductible, it must meet the requirements of Code Section 162.
IRC 162(a) states:
There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business
In essence, for a company to be able to claim a deduction, it must be able to demonstrate that:
- The expense was “ordinary” and “necessary” for the business
- The company “paid or incurred” the expense during the “taxable year”
- The expense of the company was incurred to “carry on” business
- The company was performing activities within its “trade” or “business”
Sec 162 of the Internal Revenue Code is probably one of the most commonly used legal basis by companies making business deductions.
As a result, over the years, an important body of judicial interpretation of Section 162 tax code has emerged.
Let’s look at some of the important elements of tax code 162.
Ordinary and Necessary Expenses
Ordinary and necessary business expenses are those that are incurred by the company routinely by the company and directly intended to advance its commercial interests.
For a business expense to be considered as “ordinary and necessary” under tax code 162, it does not have to be made very often or at high frequency.
Rather, the business expense should be relevant to the business ordinarily expected and necessary for the business to be able to perform its operations.
In the matter Welch v. Helvering, the US Supreme Court stated that for a business expense to be necessary, it must be “appropriate and helpful [in] the development of the [company’s] business”.
In addition, in the case Jenkins v. Commissioner, it was determined that a Sec 162 trade or business expense can be deducted when:
- The company’s motive should be assessed when incurring the expense
- Determine if there’s a sufficient connection between the company’s business and the expense
Paid or Incurred Expenses
The second element of 162 IRC is that the expense must be paid or incurred within the same fiscal year that the company is claiming the deduction.
In other words, a company having incurred business expenses during the course of this year should claim the deduction when filing its taxes for this fiscal year.
IRC Sec 162 also requires that the expense be paid or incurred by the company when carrying on its business or trade.
In other words, if an expense was not incurred when the company was carrying its business, that expense will not qualify as an IRC 162(a) deductible expense.
For example, a taxpayer deducting may not be able to deduct all business startup costs when starting a new business as some of those costs may not be considered as paid or incurred by the company in “carrying on” its business.
Trade or Business
What qualifies as a Section 162 trade or business?
This question brings us to the last element that is important for a Section 162 expense to be deductible is that the expense in question must be related to the company’s “trade” or “business”.
For an expense to be considered as part of a company’s trade or business, the company should be performing activities that:
- Have continuity
- Activities that are regularly performed
- The company’s objective is to earn an income or make money
If an expense is inherently personal or does not relate to the business or a trade, then the expense may not be deductible.
Section 162 Trade or Business Takeaways
So there you have it folks!
What is the Section 162 trade or business definition?
What can qualify as ordinary and necessary business expenses under the tax code?
Essentially, what expenses can a company deduct further to the requirements of Code Sec 162?
Section 162 is probably one of the most widely used tax codes by companies providing the legal basis to deduct expenses for tax purposes.
Section 162 a provides the tax code requirements for an expense to be deductible, namely:
- The expense must be“ordinary” and “necessary”
- “Paid or incurred” during the “taxable year”
- When “carrying on” business
- For the purpose of a “trade” or “business”
If the business expense meets the above criteria, then it can be deducted from the company’s earnings.
However, if the expense does not qualify as per the above, the company will not be able to make a tax deduction.
I hope I was able to answer your questions about Sec 162, what is a Section 162 trade or business, how is ordinary and necessary income defined, how it applies to your business expenses, and how Code 162 works in general.
Keep in mind that this article is general in nature.
If you are dealing with a tax issue relating to the Internal Revenue Code 162, you should consult a tax attorney or tax professional for advice or representation so you can get the right information to make decisions.
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Now, let’s look at a summary of our findings.
IRC Section 162 Summary
If you enjoyed this article on Internal Revenue Code 162, I recommend you look into the following terms and concepts. Enjoy!
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