Understanding Tax Deductions for Business Expenses: Can You Deduct Costs Incurred Through Multiple Businesses?
Starting a new business and expanding existing ventures often brings up important questions about tax planning and expenses. One common inquiry among entrepreneurs is whether costs associated with a service provided by one of their businesses can be deducted from another business’s income. Specifically, many individuals wonder: If they own multiple businesses, can expenses paid to one business be considered deductible for the other?
Scenario Overview
Suppose you are in the process of purchasing rental properties and also plan to establish a lawn care company. A practical question arises: If you contract your lawn care business to maintain the lawns of your rental properties, can the payments made to your lawn care company be classified as a maintenance or operating expense of your rental property business and thus be deducted from its taxable income?
Key Principles of Business Expense Deductions
The IRS generally permits the deduction of ordinary and necessary business expenses. To qualify as deductible, expenses must be:
- Directly related to the operation of the business.
- Required or appropriate for the business activity.
- Paid or incurred during the taxable year.
When dealing with multiple businesses owned by the same individual, the critical consideration is whether the expense is directly attributable to a specific business activity and whether the transaction is conducted at arm’s length, meaning it is made under fair market terms.
Can Expenses Paid to One Business Be Deducted by Another?
In the scenario where you own both Businesses A and B, and you pay Business B (your lawn company) to maintain the properties managed by Business A (your rental business), it is possible to classify these expenses as a legitimate business cost for Business A, provided certain conditions are met:
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Formal Arrangements: There should be a formal written contract between the two businesses that clearly defines the scope of services, payment terms, and responsibilities.
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Market Rates: The payments should reflect fair market value for the services rendered to avoid issues with transfer pricing or potential questions of tax avoidance.
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Business Purpose: The expense must be ordinary and necessary for the operation of Business A—in this case, maintaining the rental properties.
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Separation of Entities: Proper accounting records should be maintained, clearly delineating transactions between the two businesses. This helps substantiate the deduction and demonstrate that the expense is directly related to Business A.
Implications and Best Practices
While such arrangements are generally
