The operating costs of running your business are called business
expenses. These are costs you do not have to capitalize or include in
the cost of goods sold.
Keep business expenses separate from personal expenses. If you have
an expense that is partly for business and partly personal, deduct
only the business part.
To be 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 appropriate and helpful for your business. An expense does
not have to be indispensable to be considered necessary.
This section discusses business expenses you might have as a direct
seller. For more information on business expenses, see Publication 535.
Salaries and Wages
You can generally deduct the pay you give your employees for the
services they perform for your business. The pay may be in cash,
property, or services. It may include wages, salaries, vacation
allowances, bonuses, commissions, and fringe benefits.
If you are a sole proprietor, you cannot deduct your own salary or
any personal withdrawals you make from your business. You are not an
employee of the business.
For detailed discussions of salaries, wages, and other payments to
employees, see Publications 15, 15-B, and chapter 2 in
You can deduct as a business expense various federal, state, local,
and foreign taxes directly attributable to your direct-selling
business. Some of these taxes were discussed earlier under
Business Taxes and others are discussed next.
Most income taxes, including federal income taxes, cannot be
deducted as a business expense. You can generally deduct personal
state and local income taxes as an itemized deduction on Schedule A
Personal property tax.
You can deduct as a business expense any tax imposed by a state or
local government on personal property used in your direct-selling
You can also deduct registration fees for the right to use property
within a state or local area.
May and Julius Winter drove their car 7,000 business miles out of a
total of 10,000 miles during the tax year. They had to pay $25 for
their annual state license tags and $20 for their city registration
sticker. They also paid $235 in city personal property tax on the car,
for a total of $280. They are claiming their actual car expenses for
the year. Because they used the car 70% for business, they can deduct
70% of the $280, or $196, as a business expense.
Treat any sales tax you pay on a service or on the purchase or use
of property as part of the cost of the service or property. If the
service or the cost or use of the property is a deductible business
expense, you can deduct the tax as part of that service or cost. If
the property is merchandise bought for resale, the sales tax is part
of the cost of the merchandise. If the property is depreciable, add
the sales tax to the basis for depreciation. See Publication 551,
Basis of Assets, for information about the basis of
Do not deduct state and local sales taxes imposed on the
buyer that you must collect and pay over to the state or local
government. Do not include these taxes in gross receipts or sales.
Taxes on gasoline, diesel fuel, and other motor fuels that you use
in your business usually are included as part of the cost of the fuel.
Do not deduct these taxes as a separate item.
Interest is the amount charged for the use of borrowed money. You
can generally deduct all interest you pay or accrue in the tax year on
a debt related to your business. To take the deduction, you must have
a true obligation to pay a fixed or determinable sum of money.
No deduction is allowed for interest paid or accrued on personal
loans. If a loan is part business and part personal, allocate the
interest between the two. For more information, see chapter 5 in
During the tax year, you paid $600 interest on a car loan. You used
the car 60% for business and 40% for personal purposes. You can deduct
$360 (60% x $600) as a business expense on your Schedule C (Form 1040)
or Schedule C-EZ (Form 1040). The remaining interest ($240) is a
nondeductible personal expense.
You can generally deduct premiums you pay for the following kinds
of insurance related to your trade or business. This list is not all
- Fire, theft, flood, or similar insurance.
- Car and truck insurance on vehicles used in your business if
you do not use the standard mileage rate to figure your car
- Credit insurance to cover losses from unpaid debts.
- Liability insurance.
- Use and occupancy and business interruption insurance. This
insurance pays for lost profits if your business is shut down due to a
fire or other cause. Report the proceeds as ordinary income.
You generally cannot deduct the cost of life insurance paid on
your own life. However, see chapter 7 in Publication 535
information on when life insurance premiums are deductible.
Business and personal.
If you pay premiums for insurance coverage that is both business
and personal, deduct only the part that pays for business coverage.
For example, if you use your car 25% in your direct-selling business
and 75% for personal transportation, you can deduct 25% of your car
insurance premiums if you claim actual expenses for the use of the
When to deduct.
Under the cash method of accounting, premiums are not deductible
until paid. If you make an advance payment on an insurance policy that
covers more than one tax year, deduct only the part that buys
insurance for the current tax year. You must wait until the following
tax year to deduct the part that buys insurance for that year, and so
You are a direct seller. In June 2000, you pay $1,200 in premiums
for theft insurance effective July 2000 through June 2002 ($50 per
month). You can deduct $300 in 2000 ($50 x 6 months), $600 in
2001 ($50 x 12 months), and $300 in 2002.
An insurance dividend is a return of part of the premiums you paid.
If you receive dividends from business insurance premiums you deducted
in an earlier year, report all or part of the dividend as business
income. For more information on recovery of prior deductions, see
chapter 1 of Publication 535.
You cannot deduct the cost of basic local telephone service
(including any taxes) for the first telephone line you have in your
home, even though you may have an office in your home. However,
charges for business long distance phone calls on that line, as well
as the cost of a second line into your home used exclusively for
business, are deductible business expenses.
Leo had a separate telephone line installed in his home for his
direct-selling business. He had this phone number printed on his
business cards and always uses it only for business calls.
Leo can deduct the full amount of his business phone bill because
the phone is used exclusively for business.
Mary and George run an active direct-selling business out of their
home. For February, their phone bill was $65 ($20 for basic telephone
service and $45 for long-distance calls).
The total charge for long-distance business calls on their bill is
$31. Mary and George can deduct $31 as a business expense.
Away from home.
If you travel away from home and make a business phone call, you
can deduct the cost of the call, whether or not the rest of your
travel expenses are deductible.
Business and personal calls.
You can deduct telephone expenses only for business calls. Personal
calls do not become business calls because some business is discussed.
Lydia is interested in sponsoring others as direct sellers for her
product line. She often talks by phone with her sister who lives 50
miles away. They talk about personal matters. When Lydia mentions her
direct-selling work, she usually says something to encourage her
sister to become a direct seller too.
Lydia's phone calls to her sister are personal and nondeductible.
Their primary purpose is not to recruit her sister as a direct seller,
but to continue their personal relationship.
Discussed next are other expenses you may have as a direct seller.
License and regulatory fees paid each year to state or local
governments are generally deductible business expenses. Some licenses
and fees may have to be amortized. See chapter 9 of Publication 535
for more information.
The cost of catalogs you use in your selling business for more than
one year must be capitalized. The cost can then be recovered as
explained under Cost Recovery, earlier. If the catalogs are
used in your selling business for one year or less, you can deduct
their full cost in the tax year you pay for them.
If you must pay a bonus, percentage, or other type of commission to
direct sellers working under you, you can deduct it. Report the full
amount of any commissions you receive as business income, and deduct
the commissions you pay as ordinary and necessary business expenses.
Freda has her own direct-selling business and sponsors two other
direct sellers. These direct sellers report their sales to her each
month. She in turn adds their sales to hers and reports the total to
the direct seller who sponsored her. In March, the people working
under her each had $400 in sales and she had $500 in sales of her own.
She reports to the company (or her sponsor) $1,300 ($400 + $400 +
$500) in monthly sales for her group even though her income is only
Freda received a commission or "performance bonus" for March
equal to 10% of the $1,300, or $130, in sales. She reports the entire
$130 as business income on her tax return.
Freda must pay the direct sellers working under her a commission of
7% on their monthly sales of $400. She paid each of them $28 (7% of
$400) for their March sales. She deducts the total, $56, as a business
expense on her tax return.
If you use a computer in your direct sales business, you can
depreciate it if you use it more than 50% in your business. For more
information, see chapter 4 in Publication 946.
If you have business meetings in your home, you can deduct expenses
for the meetings only when they meet certain tests.
- The expenses of entertaining business associates in your
home are deductible if they meet the rules discussed under Meals
and Entertainment, later, and you can prove your expenses as
discussed later under Recordkeeping.
- The expenses of maintaining your home as a place of business
are deductible if you meet the tests discussed under Business Use
of Your Home, later.
Barbara and Bill hold biweekly meetings in their home for the
direct sellers who work under them. They discuss selling techniques,
solve business problems, and listen to presentations by company
Because the meetings are for business, Barbara and Bill can deduct
50% of the cost of the food and beverages they provide. The 50% limit
is explained later under Meals and Entertainment. They keep
a copy of their grocery receipts for these refreshments, and record
the date, time, and business nature of each meeting. Because the
meetings are held in their living room rather than in a special area
set aside only for business, they cannot deduct any of their home
expenses for the meetings.
If you subscribe to a journal for direct sellers, you can deduct
the annual subscription fee as a business expense.
Club dues and membership fees.
Generally, you cannot deduct amounts you pay or incur for
membership in any club organized for business, pleasure, recreation,
or any other social purpose. This includes country clubs, golf and
athletic clubs, hotel clubs, sporting clubs, airline clubs, and clubs
operated to provide meals under circumstances generally considered to
be conducive to business discussions.
None of the following organizations will be treated as a club
organized for business, pleasure, recreation, or other social purpose,
unless one of its main purposes is to conduct entertainment activities
for members or their guests or to provide members or their guests with
access to entertainment facilities.
- Boards of trade.
- Business leagues.
- Chambers of commerce.
- Civic or public service organizations.
- Professional associations.
- Trade associations.
Legal and professional fees.
Legal and professional fees, such as fees charged by accountants,
that are ordinary and necessary expenses directly related to operating
your business are deductible as business expenses. However, you
usually cannot deduct legal fees paid to acquire business assets.
Those are added to the basis of the property.
If the fees include payments for work of a personal nature (such as
making a will), you can take a business deduction only for the part of
the fee related to your business. The personal portion of legal fees
for producing or collecting taxable income, doing or keeping your job,
or for tax advice may be deductible on Schedule A (Form 1040) if you
itemize deductions. See Publication 529,
Tax preparation fees.
You can deduct as a trade or business expense the cost of
preparing that part of your tax return relating to your business as a
sole proprietor. The remaining cost may be deductible on Schedule A
(Form 1040) if you itemize deductions.
You can also take a business deduction for the amount you pay or
incur in resolving asserted tax deficiencies against your business as
a sole proprietor.
Samples and promotional items.
You can deduct the cost of samples you give to your customers and
the cost of promotional items such as posters. You cannot deduct the
cost of any samples you use personally.
You can deduct service charges you pay on orders for goods. The
service charge can be a flat charge or it can be based on other
Unless you have deducted the cost in any earlier year, you
generally can deduct the cost of materials and supplies actually
consumed and used during the tax year.
If you keep incidental materials and supplies on hand, you can
deduct the cost of the incidental materials and supplies you bought
during the tax year if all three of the following requirements are
- You do not keep a record of when they are used.
- You do not take an inventory of the amount on hand at the
beginning and end of the tax year.
- Your taxable income is clearly reflected by this