Under the U.S. tax code, businesses expenditures can be deducted from the total taxable income when filing income taxes if a taxpayer can show the funds were used for business-related activities,[1] not personal[2] or capital expenses (i.e., long-term, tangible assets, such as property).
[3] In terms of its accounting treatment, an expense is recorded immediately and impacts directly the income statement of the company, reducing its net profit.
The Internal Revenue Code, Treasury Regulations (including new regulations proposed in 2006), and case law set forth a series of guidelines that help to distinguish expenses from capital expenditures, although in reality distinguishing between these two types of costs can be extremely difficult.
[9] For example, in Fedex Corp. v. United States,[10] the taxpayer performed repairs upon jet engines by removing them from the airplane and then having parts replaced.
The court held that the inspection and replacement costs could be deducted because the improvements did not add to the value and did not prolong the life of the airplanes as a whole.
The taxpayer argued that the costs of installation were deductible and the tax court agreed.
Morris Drive-In Theatre Co. v. Commissioner,[13] under threat of litigation, the taxpayer was forced to create a new drainage system to prevent run-off rainwater from flooding his neighbor's farm.
Imagine that a business buys a truck for $50,000 and uses $5,000 this year on gasoline to distribute tomatoes upon which it earned $20,000.