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The American tax system is designed as a progressive one, which means that it is specifically used as a tool to encourage – or discourage – particular actions that are seen as positive – or negative – to society in general – according to the latest information from RG Brenner. As such the tax code has frequently played a pivotal role in encouraging small business and entrepreneurship in the United States, which is widely viewed as positive for the overall country. This means that the tax code actively encourages small business by offering all kinds of incentives and benefits to them. Among these incentives and benefits, a large number of them are deductions that can be subtracted from the business’s taxable income, thereby lowering their tax bill each year.

As with everything else related to the American tax process, the exact determination of what is deductible and to what extent an expense can be deducted varies widely and can get extremely complex. Nevertheless, the basic rule is that the expense has to meet the IRS definition of the term “ordinary” and “necessary”. By “ordinary” the IRS means that the expense has to be something that is both common and accepted in your trade, business, or industry. When the IRS says “necessary” it means that the expense has to helpful and appropriate for your business, it does not mean that the expense has to be indispensable.

The general rule described above notwithstanding, not all expenses that you may see as “ordinary” and “necessary” may be deductable. Costs of goods sold (comparative inventories over the tax year), capital expenses (such as assets and improvements), and personal expenses are generally not considered deductible by the IRS. Further, there are many “gray” expenses that may or may not be deductible and in these cases it is the IRS definitions that matter, not your personal interpretation of the tax code. While deductions can – and do – save small businesses a significant amount of money every year, they can be very complicated and the language can be misleading. Therefore it is a good idea to consult with a tax professional when deciding what to claim as deductions for your small business.