In order to be tax-deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate for your business. What does that look like in practical terms?

Rule #1 – Remember that you and your business are separate entities

When you started your business, you determined its entity structure, such as a sole proprietorship, an LLC, or an S-Corporation. One of the reasons for selecting a specific entity structure is to provide liability protection for your personal assets in case of any legal action against your business. If something negative happens in your business, you don’t want it to also impact your personal assets. But in order to maintain that “corporate veil”, your business must look and act and act like a separate entity and not like your “alter ego”.

This includes keeping separate bank accounts for yourself and your business. A separate business account provides accurate records for keeping track of your business expenses for accounting and tax purposes. Besides a bank account, having a separate business credit card can also help you track your business expenses and build your company’s credit history separate from your own.

Rule #2 – Keep good current records

Keep track of all business receipts to substantiate business tax deductions. Keeping good records can help you at tax time when determining appropriate business tax deductions, when applying for a business loan, in tracking how your business is doing, and in protecting your personal assets from any business legal issues.

Documents that support business expenses can include canceled checks, cash register tapes, account statements, credit card sales slips, invoices, and petty cash slips for small cash payments.

You need to keep records on the property you own and use in your business (such as machinery and furniture) in order to figure annual depreciation and the gain or loss when you sell the assets. Your records should show the following information:

• Date of purchase and the purchase price
• Cost of any improvements
• Section 179 deduction taken
• Deductions taken for depreciation
• Deductions taken for casualty losses, such as losses resulting from fires or storms
• How you used the asset
• When and how you disposed of the asset and the selling price
• Expenses of the sale

If you drive your personal car for business purposes, keep accurate mileage records for your business use in order to determine the proper allocation. You can deduct actual car expenses, including depreciation, lease payments, gas/oil, tires, repairs, tune-ups, insurance, and registration fees. Or alternatively you can use the standard mileage rate (67 cents per mile for 2024). Remember that commuting expenses between your home and your business location are not tax-deductible. More information on the business use of a car can be found in IRS Publication 463, Travel, Gift, and Car Expenses.

Rule #3 – Retain documentation for the appropriate length of time

You’re responsible for keeping business records for as long as the IRS might need them. In practical terms, this means keeping records that support an income or deduction item on a tax return until the period of limitations for that return runs out.

You should also keep copies of your filed tax returns. They can help in preparing future tax returns and making computations if you file an amended return.

Check out our Records Retention Guide for Businesses here on the Kindred CPA blog. And for your personal finances, visit our Records Retention Guide for Individuals.