Ordinary and Necessary Expenses (O&NE)

Ordinary and necessary expenses are business costs that are common, accepted, and appropriate for carrying on a trade or business. For U.S. federal income tax purposes these expenses are generally deductible in the year they are incurred under 26 U.S.C. §162(a), provided they meet the tests of being both “ordinary” and “necessary.”

What “ordinary” and “necessary” mean

• Ordinary: common and accepted in a particular trade or business.
• Necessary: helpful and appropriate for the business (not required to be indispensable).

Both tests must be satisfied for an expense to be deductible as an ordinary and necessary business expense.

Typical examples

Common categories of ordinary and necessary expenses include:
* Employee compensation — wages and salaries paid for services.
* Retirement plan contributions — employer contributions to plans such as 401(k), 403(b), SIMPLE, and SEP.
* Rental expenses — payments to lease property used in the business (generally not deductible if the payment creates equity or title for the payer).
* Taxes — state, local, federal, or foreign taxes directly attributable to the trade or business.
* Interest — interest on money borrowed for business activities.
* Insurance — premiums for business-related insurance.
* Business supplies and software — tools, software, uniforms, or other items commonly used in the trade.

Startup costs vs. ordinary expenses

Costs to investigate or create a new business generally are treated as capital or startup expenses rather than ordinary and necessary expenses. These startup costs are typically amortized over time and are not fully deductible as ordinary business expenses in the year incurred.

Business use of the home

Home-office deductions are allowed for expenses related to the portion of a dwelling used for business if the space qualifies as the principal place of business (even if some business is conducted elsewhere). Key points:
* Deductible items can include a prorated share of utilities, mortgage interest, repairs, and similar items.
* Deductions are based on the percentage of the home used regularly and exclusively for business.
* The taxpayer is responsible for calculating and substantiating the business-use percentage.

Key takeaways

• Ordinary and necessary expenses are common, appropriate business costs that may be deducted for tax purposes under §162(a).
• The IRS does not provide an exhaustive list; taxpayers must determine whether an expense meets the ordinary and necessary tests.
• Startup costs are usually treated as capital expenses and are typically amortized, not deducted as ordinary expenses.
• Home-office deductions are available when a portion of the home qualifies as the principal place of business and deductions are prorated by business-use percentage.

Sources: 26 U.S.C. §162; IRS Publication 535 (Business Expenses); IRS Publication 587 (Business Use of Your Home).