Question

Which of the following statements describes what is intended by the terms ordinary and necessary when referring to deductible business expenses?

The expenses must be critical for generating a profit, not just helpful.
The expenses must be less than the revenues or the activity is not profit-motivated.
The expenses must be appropriate and helpful for generating a profit.
The expenses must be repetitive in nature rather than one-time expenses.

Answer 1

Ordinary and necessary deductible business expenses must be common, accepted, and helpful for the business, but do not have to be critical or less than revenues to be profit-motivated.

Step-by-step explanation:

When it comes to deductible business expenses, the terms ordinary and necessary refer to expenses that are common and accepted in the business, as well as helpful and appropriate for generating a profit. These expenses don't need to be indispensable or critical, nor do they have to be repetitive in nature. Contrary to being less than the revenues, necessary doesn't mean that the expenses need to be less than the profits for the activity to be profit-motivated; it just needs to be something that helps in earning the revenue. It is also essential to understand the difference between accounting profit and economic profit. Accounting profit is what businesses often pay taxes on and is calculated by subtracting explicit costs from total revenue. Economic profit takes both explicit and implicit costs into account when compared to total revenue, which may include costs such as depreciation of goods, materials, and use of resources owned by the business.