Tax Deductions You Should Take and Some Crazy Ones to Avoid

Crazy (and possibly illegal) tax deductions

We asked some of our readers to tell us about the most off-the-wall tax deductions they’ve encountered. Many of these are illegal but, believe it or not, some worked. Here’s what they had to say:

“I had a client who wanted to know if he could deduct the motorcycle he recently purchased because he said that riding it relieved his stress, which helped him perform better in his business.” ― Logan Allec, certified public accountant and owner of Money Done Right

“My favorite: fees paid to a psychic fortune teller to whom one of my clients went to for ‘business advice.'” ― Logan Allec

“One client tried to deduct the cost of a shotgun. Another wanted to deduct practice range time to increase his firing accuracy.” ― Steven J. Weil, president and tax manager of RMS Accounting

“A client wanted to deduct the cost of his dog, claiming he was the company mascot and the company provides medical coverage for employees.” ― Steven J. Weil

“The swimming pool one [business] owner was having installed in his home. I asked what made it a business expense and he didn’t even have some fantastically wild rationalization, like it was to help relieve the stress of his very crazy job. He just said he wanted to reduce his taxable income.” ― Katie L. Thomas, owner of Diamond J Accounting

“I had a real estate agent try to tell me that every meal she purchased was a business expense because she wore her name tag to the restaurant, which meant everyone saw she was a real estate agent and could ask her questions.” ― Katie L. Thomas

Drug dealing and IRS Tax Code Section 280E

Perhaps one of the most out-there tax deduction stories comes to us from the 1970s in the case of Jeffrey Edmondson v. Commissioner. Edmondson was convicted of selling large quantities of methamphetamine, cocaine and cannabis. Following his conviction, the IRS attempted to claim $17,000 in back taxes from Edmondson. In return, Edmondson filed a tax return claiming normal business deductions for phone service, business trips, cost of goods sold and a portion of his rent as a “home office,” all of which related to his illegal drug-dealing activities. The IRS balked at this attempt to claim deductions and the matter ended up in court.

To the surprise of the IRS, Edmondson won the lawsuit. The court decided he was entitled to “both ordinary and necessary” business expenses related to his drug-dealing activities. The decision was handed down in 1981.

As a result, in 1982, Congress adopted Tax Code 280E, which banned businesses trafficking in Schedule I or Schedule II substances from deducting business expenses. Ironically, 280E impacts legal cannabis businesses negatively today because, although they operate in compliance with state law, they rely on a product that remains a Schedule I substance under the federal Controlled Substances Act.

Expenses you can deduct on your taxes

Crazy deductions aside, there are plenty of tax deductions your business can (and should) take to reduce your overall tax burden this year. Consider the following personal and business deductions that may reduce your tax liability.

Itemized deductions for individuals

Since the Tax Cuts and Jobs Act of 2017, the standard deduction has been significantly higher for individuals. As a result, many taxpayers now take the standard deduction instead of itemizing deductions. However, it’s still worth the extra time to track itemized deductions if you think your total deductions may exceed the standard deduction. You may also use a standard vs. itemized deduction calculator to help you decide. For every dollar your itemized deductions are greater than the standard deduction, you lower your total tax bill.

Check out these common itemized deductions:

• Medical and dental expenses: Medical and dental care for yourself, a spouse or dependents may be deducted to the extent it exceeds 7.5 percent of your adjusted gross income. This includes the costs of office visits, hospitalization, travel to and from medical care, the cost of prescription medicine and other costs related to medical care.
• State and local taxes: These deductions are limited to a total of $10,000 or $5,000 for married taxpayers filing separate returns. This tax must have been imposed directly on the taxpayer and paid within the same tax year. State and local real estate taxes may be eligible for a deduction based on the property’s value and if they’re collected for the “general public welfare.” However, you cannot deduct transfer taxes on the sale of property, homeowners association fees, estate or inheritance taxes and several other items.
• Home equity loan interest: You can deduct interest on a home equity loan or line of credit if you used the funding to “buy, build or substantially improve the taxpayer’s home that secures the loan.” You can no longer deduct interest on a home equity loan you took out to pay off credit card debt or for other purposes.
• Charitable contributions: Generally, you can deduct qualified charitable contributions of cash and property. You may also be able to deduct business charitable contributions under certain circumstances.

Other deductions are now unavailable or have additional restrictions. For example, most taxpayers can no longer take a deduction for expenses they incur as an employee.

Deductions you can take whether you itemize deductions

Some deductions are taken “above the line,” which means you can use them to reduce your income even if you don’t itemize deductions. These are called “Adjustments to Income” and are reported on Schedule 1, Part II of your individual tax return. Because these deductions reduce your adjusted gross income, which is used to determine your eligibility for certain tax benefits, they may also benefit you in other ways.

Here are some of the most common Adjustments to Income:

• Education: The student loan interest deduction is popular as it allows the taxpayer to deduct the lesser of $2,500 or the amount of interest paid during the year. Educators can also take advantage of the educator expense deduction. 
• Self-employed health insurance: If you are self-employed, you may be able to deduct your health insurance premiums as an Adjustment to Income. The policy can cover you, your spouse, dependents and children under age 27, even if they’re not your dependents. Your deduction is limited by the amount of net income from your business.
• Retirement plans: You can deduct qualified contributions to a traditional (not Roth) individual retirement arrangement (IRA) or self-employed Simplified Employee Pension, Savings Incentive Match PLan for Employees or other qualified retirement plans.

What about tax credits?

Unlike tax deductions, which lower the amount of income used to calculate your taxes, tax credits directly reduce the amount of tax you owe. Credits can bring significant savings for some taxpayers. Here are a few examples:

• Earned income tax credit: The earned income tax credit can be used by low- and moderate-income earners to receive a credit for up to $7,430 in 2023. The maximum income level for the credit depends on the number of qualifying children or relatives claimed. Taxpayers with up to $63,398 in earned income (2023) may qualify for a refundable credit. 
• Child tax credit: Families with qualifying children under age 17 may be able to take the child tax credit of up to $2,000 per child. The credit is limited or phased out at higher income levels.
• Child and dependent care credit: You may qualify for a credit if you pay someone to care for your child or other dependent while you work or look for work. For 2023, the maximum credit is $2,000, of which $1,600 may be refundable (more than your tax liability).
• Education credits: The lifetime learning credit and the American opportunity tax credit are available to help defray higher education expenses.

What else should business owners know about taxes?

Business deductions are allowed for several operational expenses. A key phrase for the IRS is that expenses must be “ordinary and necessary.” In other words, the expense is commonly accepted in the profession and is helpful and appropriate for the trade or business. 

Consider the following tax tips for business owners.

1. Organization and documentation are essential.

You must keep records of deductions and be able to find them at tax time. According to Marc Scott, a CPA with California-based M. Scott & Company, a tracking system is vital for businesses. A company can undertake various strategies to ensure its books are ready for tax season and to help it get the most out of any potential deductions.

“Having an ongoing system where you track potential expenses throughout the year is a way to keep the filing time less chaotic,” Scott advised. “At a minimum, you want the categories that are listed on the Schedule C, Form 1120 or [Form] 1065. For your internal tracking, you may have more categories than what the forms provide, but you’ll have a breakout of what deductions you’ll be taking when filing.”

2. Keep up with tax law changes.

Scott says businesses should also be aware of any changes, including those stemming from the Cuts and Jobs Act. Here are a few tax law changes you should become familiar with.

• Elimination of the entertainment expense deduction: “Entertainment expenses have been eliminated completely, so you can’t take somebody to a ballgame or out to the opera,” Scott said. “These types of use cases for expenses are officially gone.” Businesses can still deduct 50 percent of the cost of qualifying business meals, as long as you or someone from the business are present and the meals aren’t “lavish or extravagant.” Consult with a tax professional if you aren’t sure which meals qualify.
• Qualified business income reduction: If you own a sole proprietorship, partnership, S corporation, trust or estate, you may be able to reduce your business income by up to 20 percent. However, you must meet specific requirements and income limitations to qualify.

Make a plan to optimize your tax results this year

By learning about tax deductions and keeping good records throughout the year, you’re already on the right track. For more help, consult with a tax professional or investigate the options for tax preparation software. You should never hesitate to take tax deductions and credits to which you and your business are entitled. 

Derek Walter contributed to this article. Source interviews were conducted for a previous version of this article.