IRC Section 162: Ordinary and Necessary Business Expenses

Under Section 162 of the Internal Revenue Code, a business can deduct the ordinary and necessary expenses it pays or incurs while carrying on a trade or business. That single sentence controls how nearly every business, from a solo Schedule C filer to a Form 1120 corporation, reduces its taxable income. An expense that qualifies comes off gross income dollar-for-dollar. One that doesn’t stays on the books as an after-tax cost, no matter how legitimate it felt when you wrote the check.

The Three Tests Every Expense Has to Pass

Section 162(a) sets three requirements, and failing any one of them kills the deduction.¹

You Have to Be Carrying On a Trade or Business

The expense must connect to an actual, ongoing business. Courts read this to mean an activity pursued in good faith with a genuine profit motive and enough continuity to look like a real operation. Managing your personal stock portfolio doesn’t count. Flipping one item on eBay a year doesn’t count. The IRS looks at whether you keep records, adjust methods to improve profits, and put in real time.

If the IRS reclassifies your activity as a hobby, the expenses are disallowed entirely. That scrutiny hits hardest when a side venture posts losses year after year with no realistic path to profit.

The Expense Has to Be Ordinary

An ordinary expense is one that’s common and accepted in your particular industry. It doesn’t have to happen every month or even every year. A construction firm buying liability insurance is ordinary. A bakery hiring a food safety consultant after an inspection is ordinary. The question is whether other businesses in your field routinely spend money on the same kind of thing.

The Expense Has to Be Necessary

Necessary means helpful and appropriate to your business. It’s a lower bar than the word suggests. The expense doesn’t have to be essential for survival. If a reasonable owner in your position would spend the money to advance the business, it’s necessary. A landscaping company buying branded uniforms for its crew clears this easily, even though the company could technically operate without them.

Paid or Incurred During the Tax Year

The expense has to fall in the tax year you’re claiming it, and how that gets measured depends on your accounting method. Cash-basis: you deduct when you actually pay. Accrual-basis: you deduct when all events creating the liability have occurred and the amount can be determined with reasonable accuracy, regardless of when cash changes hands.²

Deduct Now or Depreciate Over Time

Passing the Section 162 tests doesn’t automatically give you an immediate write-off. Section 263 draws a hard line: costs that create an asset or produce a benefit lasting well beyond the current tax year must be capitalized and recovered over time through depreciation, amortization, or depletion.³

The practical dividing line is what the spending accomplishes. Replacing a broken window is a repair, deductible in full. Replacing the entire roof with upgraded materials that extend the building’s useful life is an improvement and has to be capitalized. The IRS looks at whether the work adds value, substantially extends the asset’s life, or adapts it to a different use.⁴

Most tangible business property is depreciated under MACRS, which assigns each asset type a recovery period: five years for computers, seven years for office furniture, 39 years for commercial buildings.⁵ Three provisions let you accelerate that timing, and they matter for most businesses buying equipment.

The De Minimis Safe Harbor

The de minimis safe harbor lets you expense small purchases immediately instead of capitalizing them. If your business has an applicable financial statement (audited, SEC-filed, or similar), you can deduct items costing up to $5,000 per item or invoice. Without one — the situation for most small businesses — the threshold is $2,500 per item or invoice.⁶ The election is made annually by attaching a statement to your timely filed return.

Section 179 Expensing

Section 179 lets you deduct the full cost of qualifying property in the year you place it in service. For 2026, the maximum deduction is $2,560,000, and it phases out dollar-for-dollar once total equipment purchases exceed $4,090,000. Qualifying property includes machinery, equipment, off-the-shelf software, and certain improvements to nonresidential buildings such as HVAC systems and roofing.

Bonus Depreciation

Bonus depreciation under Section 168(k) originally allowed a 100% write-off of qualifying new and used assets in the year placed in service. The TCJA’s original schedule phased that down starting in 2023, heading to zero in 2027. The One, Big, Beautiful Bill Act restored 100% bonus depreciation. Unlike Section 179, bonus depreciation has no dollar cap, which makes it the primary tool for large asset purchases.

How the Test Plays Out in Real Expense Categories

The rules below apply on top of the general Section 162 requirements. Each category has its own limits or documentation quirks.

Compensation and Professional Fees

Wages, salaries, bonuses, and other compensation for services are deductible when reasonable for the work actually performed.¹ The reasonable requirement is where closely held businesses stumble. When an owner-employee of a corporation sets their own salary, the IRS will compare it against what similar businesses pay for similar work, factoring in qualifications, hours, and revenue. Compensation deemed excessive gets recharacterized as a non-deductible dividend distribution.

Fees paid to outside lawyers, accountants, consultants, and bookkeepers are deductible when tied to ongoing operations. One important carve-out: professional fees connected to acquiring or selling a capital asset must be capitalized as part of the transaction cost rather than deducted immediately.

Business Travel

Travel is deductible when you’re away from your tax home overnight or long enough to require sleep or rest. Your tax home is generally the city or area where your main place of business sits, not necessarily where you live. Deductible costs include airfare, train tickets, car rentals, lodging, and incidentals like tips and dry cleaning.

Drive your own vehicle for business, and you can use either the standard mileage rate or actual expenses (gas, insurance, depreciation, maintenance) applied to the business portion of your driving. The 2026 standard mileage rate is $0.725 per mile.⁷ Lodging for you is fully deductible; lodging for a spouse or family member along without a business purpose is not.

Business Meals

You can deduct 50% of business-related meal costs. The meal can’t be lavish, and you or an employee has to be present when the food is served. Workers subject to Department of Transportation hours-of-service rules — long-haul truckers, for example — get 80% for meals consumed on duty.⁸

Documentation is everything here. Record the amount, date, location, business purpose, and business relationship of everyone present. Without those details, the IRS can wipe out the entire deduction, and meals are one of the most frequently audited categories.

Rent, Utilities, and the Home Office

Rent for office space, warehouses, retail locations, or leased equipment is fully deductible as long as you’re not building equity or taking title through the payments. Utilities used for business — electricity, water, gas, internet, phone — are fully deductible.

Work from home, and only the portion allocated to a workspace used exclusively and regularly for business qualifies. The regular method uses Form 8829 to calculate the business percentage of your home.⁹ The simplified method lets you deduct $5 per square foot up to 300 square feet ($1,500 maximum).¹⁰ Simplified saves paperwork; regular usually produces a larger deduction for bigger workspaces.

Insurance Premiums

Premiums for business insurance — general liability, professional liability, property, workers’ compensation, commercial auto — are deductible as ordinary and necessary expenses. Self-employed individuals can also deduct health insurance premiums (medical, dental, vision, and qualifying long-term care) for themselves, their spouse, and dependents. This one goes on your personal return as an adjustment to income, not on Schedule C, and the plan must be established under your business.¹¹

One limitation catches owners off guard. You can’t take the self-employed health insurance deduction for any month you were eligible to participate in an employer-subsidized plan — through your own employer, your spouse’s employer, or a dependent’s employer — even if you never enrolled.¹¹

Life insurance premiums are not deductible when the business is directly or indirectly the beneficiary. Key person coverage on an essential employee or owner produces tax-free proceeds when it pays out, but premiums come from after-tax dollars.¹²

Advertising and Marketing

Advertising costs are broadly deductible: print ads, online advertising, social media campaigns, SEO services, direct mail, signage, promotional materials. Website hosting, maintenance, and updates get the same treatment. Initial website development sits in a gray area — some tax professionals treat it as a capital cost similar to software, amortized over three years, others expense it under Section 179. Either way the cost is recoverable; the question is timing.

Education and Training

Education is deductible when the training maintains or improves skills you already use, or when your employer or a licensing authority requires it to keep your job or professional standing.¹³ A CPA taking CE courses, a real estate agent at a negotiation seminar, a nurse completing required recertification — all deductible.

Education that qualifies you for a new trade or business is not deductible, even when it looks related to what you do now. A dentist can’t deduct medical school tuition. A change in duties within the same general type of work doesn’t create a new trade or business, so a marketing employee getting an MBA may or may not qualify depending on how the degree actually reshapes their career.¹³

Start-Up and Organizational Costs

Money spent before your business officially opens — market research, employee training, scouting locations, travel to line up suppliers — falls under Section 195 as start-up costs. These expenses meet the ordinary and necessary test but fail the “carrying on” requirement because the business doesn’t exist yet.

In the year your business begins, you can elect to deduct up to $5,000 of start-up costs immediately. That allowance shrinks dollar-for-dollar once total start-up costs pass $50,000.¹⁴ Anything beyond the immediate deduction is amortized over 180 months starting the month the business opens.¹⁵ Corporations get a parallel rule under Section 248 for organizational costs like incorporation fees, with the same $5,000 immediate deduction and 180-month structure.¹⁶

Bad Debts

When a customer owes you money and the debt becomes worthless, Section 166 allows a full deduction in the year the debt goes bad. Partial worthlessness is deductible to the extent you’ve charged it off, but only with IRS approval.¹⁷ The debt has to have been created in connection with your trade or business. A loan to a friend that goes south is a nonbusiness bad debt and gets less favorable treatment as a short-term capital loss.

Business Interest

Interest on business loans — lines of credit, equipment loans, commercial mortgages — is generally deductible under Section 163. Section 163(j) caps the deduction for larger businesses at 30% of adjusted taxable income, plus business interest income and floor plan financing interest. Small businesses are exempt if their average annual gross receipts over the prior three years fall below the inflation-adjusted threshold, which was $31 million for 2025.¹⁸ Most small businesses clear that exemption comfortably.

What the Code Blocks Even When It Looks Ordinary

Some spending is disallowed regardless of how ordinary or necessary it feels. These are policy choices, not judgments about whether the expense actually helped your business.

Personal Expenses

Section 262 flatly prohibits deducting personal, living, or family expenses.¹⁹ Your daily commute, groceries, and clothing suitable for everyday wear stay personal even when they exist because of work. A business suit isn’t deductible because you could wear it to a wedding. Uniforms or specialized protective gear that aren’t suitable for street wear can qualify, but the bar is high.

Entertainment

Since the TCJA took effect in 2018, business entertainment is completely non-deductible. Sporting events, concerts, golf outings, and other amusement or recreation don’t qualify no matter how much business you conduct there. Club dues for any club organized for business, social, or recreational purposes are also out.²⁰

Narrow exceptions remain: recreational events primarily for non-highly-compensated employees (a company holiday party), goods made available to the general public, and expenses treated as taxable compensation to the recipient stay deductible.²¹ Buy a client dinner at an entertainment event and you can still deduct 50% of the meal, but only if the food is purchased separately or itemized on a separate invoice.

Fines and Penalties

Section 162(f) bars deductions for fines and penalties paid to a government for violating any law, civil or criminal. Traffic tickets, OSHA penalties, environmental fines, tax penalties — all disallowed. Amounts paid as restitution, remediation, or to come into compliance with a law can still be deductible, but the court order or settlement must specifically identify them that way.²² A vague settlement that lumps everything together won’t preserve the deduction, which makes the settlement language one of the highest-value things your attorney can get right.

Lobbying and Political Contributions

Section 162(e) blocks deductions for expenses tied to influencing legislation, participating in political campaigns, attempting to sway the public on legislative matters, or communicating with executive branch officials to influence their positions. Contributions to candidates, parties, and PACs are also non-deductible. A small exception exists for in-house lobbying expenditures under $2,000 per year, excluding overhead.²³ Simply monitoring legislation without trying to influence it is fine.

Business Gifts

Gifts to clients or business contacts are deductible up to $25 per recipient per year.²⁴ That cap has not been adjusted for inflation since it was enacted. Incidental items costing $4 or less with your company name permanently imprinted — pens, notepads, keychains — don’t count against the limit. Promotional materials like display racks used on the recipient’s business premises are also excluded.

Records That Make the Deduction Stick

No deduction survives an audit without documentation. The IRS wants records supporting every item of income and deduction for as long as they may be relevant, and for most returns that means at least three years after filing. Underreport gross income by more than 25% and the period stretches to six years.²⁵

Travel, meals, and gifts carry heightened substantiation rules under Section 274(d). You need documentation of the amount, time and place, business purpose, and business relationship of the people involved.²⁶ A credit card statement showing $85 at a restaurant isn’t enough on its own. You need a note explaining who was there and what business you discussed. Write it down as it happens; reconstructing months later from memory is exactly what falls apart under examination.

Digital records are fine. The IRS accepts electronic storage as long as the system accurately reproduces the originals and has an indexing method that lets you retrieve specific records on request. For depreciable property, hold on to the records until the statute of limitations expires for the year you dispose of the asset — the original basis remains relevant the entire time you own it.²⁵

1
Office of the Law Revision Counsel. 26 USC 162: Trade or Business Expenses
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eCFR. 26 CFR 1.162-1 – Business Expenses
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Office of the Law Revision Counsel. 26 USC 263: Capital Expenditures
4
eCFR. 26 CFR 1.263(a)-1 – Capital Expenditures; In General
5
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
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Internal Revenue Service. Notice 2015-82: Increase in De Minimis Safe Harbor Limit
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IRS. 2026 Standard Mileage Rates
8
Office of the Law Revision Counsel. 26 USC 274: Disallowance of Certain Entertainment, Etc., Expenses – Section 274(n)(3)
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Internal Revenue Service. Instructions for Form 8829 (2025)
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Internal Revenue Service. Simplified Option for Home Office Deduction
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Internal Revenue Service. Instructions for Form 7206
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eCFR. 26 CFR 1.264-1 – Premiums on Life Insurance Taken Out in a Trade or Business
13
eCFR. 26 CFR 1.162-5 – Expenses for Education
14
Office of the Law Revision Counsel. 26 USC 195: Start-Up Expenditures
15
eCFR. 26 CFR 1.195-1 Election to Amortize Start-Up Expenditures
16
Office of the Law Revision Counsel. 26 U.S. Code 248 – Organizational Expenditures
17
Office of the Law Revision Counsel. 26 U.S. Code 166 – Bad Debts
18
Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
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Office of the Law Revision Counsel. 26 USC 262 – Personal, Living, and Family Expenses
20
Office of the Law Revision Counsel. 26 USC 274: Disallowance of Certain Entertainment, Etc., Expenses – Section 274(a)(3)
21
Office of the Law Revision Counsel. 26 USC 274: Disallowance of Certain Entertainment, Etc., Expenses – Section 274(e)
22
Federal Register. Denial of Deduction for Certain Fines, Penalties, and Other Amounts; Related Information Reporting
23
Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses – Section 162(e)(4)(B)
24
Office of the Law Revision Counsel. 26 USC 274: Disallowance of Certain Entertainment, Etc., Expenses – Section 274(b)
25
Internal Revenue Service. Publication 583 Starting a Business and Keeping Records
26
Office of the Law Revision Counsel. 26 USC 274: Disallowance of Certain Entertainment, Etc., Expenses – Section 274(d)