Deducting Invention Business Operating Expenses

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Section 162 of the Internal Revenue Code provides that a taxpayer may deduct all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Section 162 is the true workhorse expense provision of the tax code, allowing business owners to deduct most of their day-to-day business expenses, such as office rent and salaries. Indeed, most business owners other than inventors have to rely solely on Section 162 to currently deduct their expenses (other than those they can deduct under Section 179).

Any expense is deductible under Section 162 as long as it is:

  • ordinary and necessary,
  • directly related to your business, and
  • reasonable in amount.

Expense must be ordinary

An expense must be “ordinary” to be currently deductible under Section 162. An expense is ordinary only if it is a current expense -- that is, has a useful life of less than one year. This includes anything you buy for your business that gets used up, wears out or becomes obsolete in less than one year.

Expense must be necessary

An expense is necessary if it is common, accepted, helpful and appropriate for your inventing business. An expense doesn’t have to be indispensable to be necessary; it need only help your inventing business in some way, even in a minor way. It’s usually fairly easy to tell if an expense passes this test.

EXAMPLE 1: Bill, a surgeon who invents in his spare time, hires a technician to help him design a new surgical instrument and pays him $25 per hour. This is clearly a deductible business expense. Hiring assistants is a common and accepted practice among inventors. The assistant’s fee is an ordinary and necessary expense for Bill’s inventing business.

EXAMPLE 2: Surgeon Bill visits a masseuse every week to work on his bad back. Bill claims the cost as a business expense, reasoning that avoiding back pain helps him concentrate on his inventing. This is clearly not an ordinary or customary expense for an inventor and the IRS would likely not allow it as a business expense.

Expense must be related to your business

An expense must be related to your business to be deductible. That is, you must use the item you buy for your business in some way. For example, the cost of a personal computer is a deductible business expense if you use the computer to help create an invention.

You cannot deduct purely personal expenses as business expenses. The cost of a personal computer is not deductible if you use it just to play computer games. If you buy something for both personal and business reasons, you may deduct the business portion of the expense. For example, if you buy a cellular phone and use it half the time for business calls and half the time for personal calls, you can deduct half the cost of the phone as a business expense.

However, the IRS requires you to keep records showing when the item was used for business and when for personal reasons. One acceptable form of record would be a diary or log with the dates, times and reason the item was used. This kind of record keeping can be burdensome and may not be worth the trouble if the item isn’t very valuable.

Deductions must be reasonable

There is usually no limit on how much you can deduct as long as it’s not more than you actually spend and the amount is reasonable. Certain areas are hot buttons for the IRS -- especially entertainment, travel and meal expenses. The IRS won’t allow such expenses to the extent it considers them lavish.

Common Deductions for Inventors

Common ordinary and necessary business expenses for independent inventors include:

  • accounting fees
  • bank fees for your inventing business
  • bank account
  • costs of renting or leasing equipment,
  • machinery, and other property used in
  • your inventing business
  • education expenses -- for example, the
  • cost of attending professional seminars or classes related to your inventing business
  • expenses for the business use of your home
  • fees you pay to self-employed workers you hire to help your business -- for example, the cost of paying a marketing consultant to advise you on how to market your invention
  • insurance for your business -- for example, liability and business property insurance
  • interest on business loans and debts -- for example, interest you pay for a bank loan you use to fund your invention
  • license fees -- for example, fees for a local business license
  • office expenses, such as office supplies office utilities
  • postage
  • repairs and maintenance for business
  • equipment such as a photocopier or fax
  • machine
  • subscriptions for scientific, technical or
  • business publications
  • business-related travel, meals and entertainment, and
  • wages and benefits you provide your
  • employees