40.8 Nondeductible Expense Items

Capital expenditures may not be deducted. Generally, the cost of acquiring an asset or of prolonging its life is a capital expenditure that must be amortized over its expected life. If the useful life of an item is less than a year, its cost, including sales tax on the purchase, is deductible. Otherwise, you generally may recover your cost only through depreciation except to the extent first-year expensing applies (42.3). IRS regulations provide safe harbors, including a “12-month” rule, for expenditures relating to intangible assets or benefits (40.3).

Caution

Penalties and Fines

Penalties or fines paid to a government agency because of a violation of any law are not deductible. You may deduct penalties imposed by a business contract for late performance or nonperformance.

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Expenses while you are not in business.

You are not allowed to deduct business expenses incurred during the time you are not engaged in your business or profession.

Bribes and kickbacks.

Bribes and kickbacks are not deductible if they are illegal under a federal or a generally enforced state law that subjects the payer to a criminal penalty or provides for the loss of license or privilege to engage in business. A kickback, even if not illegal, is not deductible by a physician or other person who has furnished items or services that are payable under the Medicare or Medicaid programs. A kickback includes payments for referral of a client, patient, or customer.

In one case, the IRS, with support from the Tax Court and a federal appeals court, disallowed a deduction for legal kickbacks paid by a subcontractor. The courts held that the kickbacks were not a “necessary” business expense because the contractor had obtained nearly all of its other contracts without paying kickbacks, including contracts from the same general contractor bribed here.