IRS Publication 535: A guide for small business owners

If you're not aware of all the deductions and write-offs available to you as a small business owner, you may be overpaying on taxes. Learning how to deduct the correct business expenses can help you reduce your annual tax liability and keep more of your business income.

‍You can use IRS Publication 535 as a resource to learn about the most common business tax deductions and avoid the consequences of incorrectly deducting expenses.

We’ll dive into IRS publication 535, its current status, which expenses qualify, and how you can use these guidelines as a small business owner to save money each tax year.

What is IRS Publication 535?

IRS Publication 535 is a tax guidance document specifically for businesses, including partnerships, sole proprietorships, or self-employed individuals. It covers what expenses can be deducted, how to do so, and which records to keep to be fully compliant with IRS rules.

If you’re a sole proprietor, you’ll typically report these expenses on Schedule C, which you file along with your personal income tax return (Form 1040). The business expense categories covered by Publication 535 are the costs you incur from running your business.

Is Publication 535 still in use?

The IRS discontinued Publication 535 after the 2022 tax year and provides a list of publications that have since superseded it. However, Pub 535 is still accessible on the web and provides helpful information about what expenses are deductible and how to deduct them.

Before filing your taxes, always check the latest IRS updates for the most accurate information. You may also consult a tax professional who will be up to date on current IRS rules and changes.

How is Publication 535 different from other IRS publications?

IRS Publication 535 differs from other publications because it covers general business expenses. It can be used as a broad overview of deductible expenses for businesses.

These four IRS publications are current and more specific and will help round out the information you need to correctly file your taxes.

Publication 334

Publication 334, Tax Guide for Small Business, covers topics from filing requirements to payment options. It also includes current information for small businesses on what expenses can be deducted.

Publication 463

Businesses often misstate or incorrectly deduct small business tax deductions for travel, entertainment, and gifts. Publication 463, Travel, Gift, and Car Expenses, provides guidance on how to do this correctly.

Publication 525

Publication 525, Taxable and Nontaxable Income, details the different types of taxable and nontaxable income and provides instructions on how to calculate taxes on certain types of income, such as pensions and insurance proceeds.

Publication 529

Publication 529, Miscellaneous Deductions, explains miscellaneous deductions, such as certain fines and penalties. However, most of these items must meet specific requirements to be deductible.

What expenses can I deduct?

First, to deduct any business expense, it must be ordinary and necessary, which means:

• The expense is common or ordinary for businesses in your industry
• The expense is necessary to operate in your industry, even if it's not indispensable

For example, rent is a necessary expense you can deduct from your taxes. However, if you rent your home and use it for business purposes, you can only deduct the portion of rent that is attributable to business use of your home, not the portion that's for personal use.

You must allocate expenses such as rent, utilities, and insurance based on the percentage of your home used exclusively for business.

While charitable contributions may be deductible, they are generally not considered business expenses unless made by a corporation. Sole proprietors typically deduct these on their personal return, not their business return, so check IRS guidelines carefully to avoid misclassifying them.

Can I deduct capital expenses?

You can deduct costs such as rent immediately, while you'd typically deduct capital expenses over a longer period of time.

For example, business assets such as machinery or real estate are deductible but are subject to capitalization and depreciation. This means you can't deduct the cost when you incur it, but you can deduct it over time as you depreciate property using IRS-approved schedules.

In addition to depreciation, businesses involved in extracting natural resources—such as timber, oil, or minerals—may also qualify for depletion deductions, which allow you to recover the cost of those resources over time.

If, after reviewing IRS publications, you have doubts about whether your expenses are ordinary and necessary or whether they must be capitalized, consider consulting a tax professional.

Cash vs. accrual accounting

Your method of accounting, whether cash or accrual, also determines when and how you can deduct certain expenses.

With the cash method, you can only deduct expenses when you pay them. Under the accrual method, you can deduct expenses when you've incurred them and are legally obligated to pay, even if you haven't actually paid yet.

Publication 535 and Publication 334 provide further guidance on which expenses you can deduct under each method. Your accountant can also help you determine which accounting method is best for your business.

Most common deductible business expenses

Some taxes paid by businesses, such as excise taxes on fuel or heavy vehicle use, may also be deductible depending on your industry and usage. The list of items that qualify for deduction is long, but here are some highlights.

• Raw materials
• Storage
• Repairs and maintenance
• Transportation and car expenses
• Utilities
• Business interest
• Partial self-employment tax
• Some property taxes
• Employees' pay
• Rent
• Insurance premiums
• Advertising and marketing
• Office expenses
• Supplies
• Travel expenses

One major category of deductible expenses is the cost of goods sold (COGS), which includes the direct costs associated with producing or purchasing the products you sell. You typically subtract this amount from your gross receipts to calculate gross profit.

Employee wages must be reported on Form W-2 to qualify as a deductible payroll expense.

Consult IRS Publication 334 for the full current list of allowable deductions and instructions on how to deduct them.

Key deductible areas

There are a few key categories that include some of the most common small business deductions:

Startup costs

Business startup expenses can provide valuable tax benefits when you know how to claim them properly.

• What qualifies as a startup cost: Expenses incurred before your business begins operations, such as market research, advertising, employee training, and professional fees for setting up the business structure

The IRS allows you to deduct up to $5,000 in startup costs during your first year, with remaining amounts spread over 15 years. This deduction phases out dollar-for-dollar once startup costs exceed $50,000, so timing your business launch can affect your tax savings.

Some startup costs may also be subject to amortization, meaning they’re deducted gradually over several years instead of all at once.

Home office expenses

Your home office can generate significant deductions if it meets specific IRS requirements.

• Criteria for qualifying a home office: The space must be used regularly and exclusively for business purposes, serving as either your main place of business or for meeting clients and customers

You can choose between two calculation methods. The simplified method allows $5 per square foot up to 300 square feet, while the regular method is based on the percentage of square footage of your home used by your business. The regular method requires detailed expense tracking but often yields larger deductions for businesses with substantial home office costs.

Meals and entertainment

Business dining and entertainment expenses follow specific rules that have evolved considerably in recent years.

• What meal and entertainment expenses are deductible: Business meals are generally 50% deductible when you're present, and the meal serves a business purpose, while most entertainment expenses are no longer deductible

The Tax Cuts and Jobs Act (TCJA) of 2017 eliminated the deduction related to entertainment, amusement, or recreation expenses. Its provisions expire at the end of 2025, so this may change depending on new acts of Congress or IRS rules.

Business bad debts

Unpaid customer invoices can sometimes provide tax relief through bad debt deductions.

• What constitutes a bad debt: Money owed to your business that becomes completely worthless and uncollectible, typically involving customers who cannot or will not pay legitimate business debts

You must have already included the income in your taxable earnings and made reasonable collection efforts. Document your attempts to collect payment, then write off the debt in the year it becomes worthless. Bad debt is non-deductible for taxpayers who use cash-basis accounting since they never reported the income.

Staying compliant with IRS guidelines

Proper documentation separates legitimate business deductions from potential audit headaches. Keep detailed records that clearly show the business purpose, amount, date, and parties involved for each expense. Expense receipts, invoices, bank statements, and credit card records form the foundation of your documentation system.

Store physical receipts in organized files and consider digital backup copies. For meals and entertainment, note the business relationship of attendees and discussion topics. Travel expenses require additional details, such as destination, date, and business purpose.

Mileage logs should include starting point, destination, odometer readings, and business reason for each trip. You can then calculate your vehicle-related deduction using either actual costs or the standard mileage rate, which the IRS updates annually.

Tax laws change frequently, and individual circumstances vary significantly. It's worth repeating that IRS Pub 535 has been discontinued as of the 2022 tax year. Review current IRS publications or consult a qualified tax professional before making deduction decisions that could affect your tax liability.

Consequences of incorrect write-offs

One of the most important things to remember when deducting expenses is that they must be legitimate business expenses. If you try to deduct personal expenses or exaggerate the amount of an expense, you could face severe consequences, including audits and penalties.

The IRS can disallow deductions they deem to be improper. This means you can’t deduct the expense on your tax return. They can also assess penalties and interest on unpaid federal tax owed due to incorrect or disallowed deductions. The IRS may even pursue criminal charges. This is typically reserved for cases of tax fraud, which is defined as willfully attempting to evade taxes.

Even if you can take an expense deduction, you must still keep records to prove the business nature of the expense. This is typically done by keeping receipts or invoices. Receipt and invoice tracking can quickly become a thorn in the side of small businesses, so automation or digitization are ideal for this purpose.

If you can't provide documentation for an expense, the IRS may disallow the deduction. Keep good records and speak with a tax professional if you have any questions about deductions.

How Ramp helps you track and categorize deductible expenses

Ramp's modern finance operations platform helps you track and categorize expenses, manage invoices, and pay bills automatically. Our software also makes it easy to generate reports, which can save you a significant amount of time when you start preparing for tax season.

With seamless accounting integration capabilities, you'll be able to track every dollar spent in real time to identify eligible write-offs and maximize deductions. If you're looking for an easier way to manage your business expenses, try an interactive demo and see why more than 40,000 businesses have saved 27.5 million hours with Ramp.