IRC 162(a) and 162(e): Ordinary and Necessary Business Expenses, Lobbying Disallowance, and OBBBA Meal Deduction Changes

IRC 162(a) Ordinary and Necessary Standard

IRC 162(a) permits a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. The deduction is available to individuals, partnerships, corporations, S corporations, and other entities engaged in a trade or business. Four distinct requirements must each be met before an expense is deductible: (1) the expense must be ordinary; (2) the expense must be necessary; (3) the expense must be paid or incurred in connection with a trade or business, not merely an income-producing investment activity; and (4) the amount must be reasonable.

"Ordinary": Normal, Usual, or Customary

The Supreme Court defined "ordinary" in Welch v. Helvering, 290 U.S. 111 (1933). The Court held that an expense is ordinary if it is normal, usual, or customary in the taxpayer's trade or business. "Ordinary" does not mean that the expense must recur regularly or that the specific taxpayer has incurred it before. Instead, it asks whether similarly situated businesses in the same industry or trade commonly incur this type of expense. A corporate taxpayer that voluntarily repays debts of a predecessor company is not incurring an "ordinary" business expense, even if the motive is to preserve business relationships, because that type of voluntary repayment is not a common practice in the industry. Practitioners analyzing novel or unusual expenditures should look to whether the expense is common across the industry, not whether it is common to this particular client.

"Necessary": Appropriate and Helpful

The Supreme Court defined "necessary" in Commissioner v. Heininger, 320 U.S. 467 (1943). The Court held that an expense is necessary if it is "appropriate and helpful" to the business, expressly rejecting any requirement that the expense be strictly required or indispensable. This is a low bar in isolation: most expenses a business actually chooses to incur for a genuine business purpose will satisfy the "necessary" requirement. The harder analytical work typically comes from the "ordinary" requirement and the trade-or-business requirement. When a taxpayer's motive is mixed (partly personal, partly business), practitioners must determine whether the dominant purpose is business, because a primarily personal expenditure that also benefits the business will not satisfy the "necessary" standard for full deductibility.

Trade or Business Requirement

IRC 162 applies only to expenses incurred in carrying on a trade or business. The Internal Revenue Code does not define "trade or business," but the Supreme Court in Commissioner v. Groetzinger, 480 U.S. 23 (1987), held that to be in a trade or business, the taxpayer must be involved in the activity with continuity and regularity, and the taxpayer's primary purpose must be for income or profit. Sporadic, isolated, or hobby activities do not qualify. Expenses incurred in an activity that does not rise to the level of a trade or business may be deductible under IRC 212 (investment expenses) if the activity is for the production of income, but different and generally less favorable rules apply (see the IRC 162 vs. IRC 212 section below). See also the related discussion in our guide to the IRC 183 hobby loss rules for the nine-factor profit presumption test.

Reasonableness of Amount

Even when an expense is ordinary and necessary in kind, the deductible amount must be reasonable. The Code does not set a statutory reasonableness ceiling for most categories, but the regulations and case law establish that extravagant or lavish expenditures may be partially disallowed. This standard arises most frequently in the context of owner-employee compensation (whether the amount paid is reasonable compensation for services rendered versus a disguised dividend), but it also applies to other categories such as rents paid to related parties, professional fees, and travel and entertainment costs. Practitioners should document the basis for the amount of significant expenditures, particularly in related-party transactions.

Capital Expenditure Carve-Out (IRC 263)

IRC 162 does not permit a deduction for amounts that are capital expenditures within the meaning of IRC 263. The distinction between a currently deductible expense and a capital expenditure is one of the most frequently litigated questions in business taxation. Generally, costs that create or enhance a separate asset, or that provide benefits beyond the current taxable year, must be capitalized under IRC 263A (UNICAP) or general capitalization principles and recovered through depreciation, amortization, or depletion. Practitioners should apply the "INDOPCO" principles (INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992)) alongside the tangible property regulations under Treas. Reg. sec. 1.263(a)-1 through -3 when classifying costs as currently deductible versus capital.

Cohan Rule and Business Expense Documentation

The Cohan rule originates from Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930), in which Judge Learned Hand held that when a taxpayer has clearly incurred deductible business expenses but cannot produce complete records, the Tax Court should estimate the deductible amount rather than disallow the deduction in its entirety. The rule reflects the practical reality that legitimate business expenses are often incurred in circumstances where perfect recordkeeping is impractical, and a total disallowance would be a windfall to the government that bears no relationship to taxable income. To benefit from the Cohan rule, the taxpayer must demonstrate some credible basis for estimation -- partial records, credible testimony, or business practice evidence -- not merely an unsupported assertion that expenses were incurred.

One critical limitation: the Cohan rule is categorically unavailable for business meals, travel, entertainment, gifts, and listed property, all of which are governed by the strict contemporaneous written substantiation requirements of IRC 274(d). See the Compliance Traps section below.

Practical Documentation Framework

For business expenses subject to the general IRC 162(a) standard (where the Cohan rule remains available), practitioners should still counsel clients to maintain contemporaneous records that establish: (1) the amount of the expenditure; (2) the date paid or incurred; (3) the business purpose served; (4) the payee or vendor; and (5) the connection between the expenditure and the taxpayer's trade or business. For expenses governed by IRC 274(d) (meals, travel, entertainment, gifts, listed property), contemporaneous written records must additionally establish the business relationship of each person present or receiving a gift. Bank statements and credit card records corroborate amounts and dates but do not satisfy the business purpose and relationship requirements without supplemental notation. A dedicated expense log, travel diary, or annotated receipt file maintained contemporaneously is the most audit-defensible approach.

See the OBBBA 2026 tax preparer guide for additional guidance on how the OBBBA meal deductibility change interacts with IRC 274(d) documentation requirements: OBBBA 2026 tax preparer guide.

IRC 162(e) Lobbying Disallowance

IRC 162(e) bars a deduction for amounts paid or incurred in connection with four categories of activity: (1) influencing federal or state legislation (including direct lobbying of legislators and grassroots lobbying communications); (2) directly communicating with covered executive branch officials to influence their official actions or positions; (3) influencing the official actions or positions of other federal or state officials or employees; and (4) participating in or intervening in any political campaign on behalf of any candidate for public office, or any attempt to influence the general public with respect to elections, legislative matters, or referenda.

Exception: Local Legislation

IRC 162(e)(2) provides a statutory exception for amounts paid or incurred in connection with legislation of direct interest to the taxpayer's trade or business before a local council or similar governing body. "Local" means a city, county, township, or similar local governmental entity, not a state legislature or Congress. "Direct interest" is a substantive requirement: the legislation at issue must directly and specifically affect the taxpayer's own trade or business operations at that location. A national retailer lobbying its local city council about zoning changes that would affect its retail location satisfies "direct interest." The same retailer lobbying on general transportation or infrastructure policy does not automatically qualify simply by virtue of being a local government proceeding.

Covered vs. Exempt Activities and Allocation

Most businesses and trade associations engage in a mix of lobbying activities (disallowed under IRC 162(e)) and non-lobbying government affairs or policy activities (potentially deductible as ordinary and necessary business expenses). Examples of non-lobbying activities that may remain deductible include: monitoring proposed regulations for business planning purposes; reviewing and analyzing the text of pending legislation without communicating with officials; and responding to regulatory requests for comment that do not constitute lobbying. The key allocation challenge is that employees, attorneys, and government affairs staff often perform both lobbying and non-lobbying work. A defensible allocation methodology must be based on contemporaneous time records or project logs that distinguish covered lobbying activities from deductible non-lobbying government affairs work. Blanket estimates or end-of-year reconstructions face heightened scrutiny in examination.

In-House vs. Outside Lobbyist Costs

IRC 162(e) applies equally to outside lobbyist fees and to the allocable portion of in-house employee compensation and overhead attributable to lobbying. For outside lobbyist retainers and fees, the lobbying vs. non-lobbying split is often available from the lobbyist's invoices or disclosure filings under the Lobbying Disclosure Act. For in-house employees (government affairs staff, attorneys, executives who personally lobby), the disallowed amount is the employee's compensation multiplied by the time fraction allocable to covered lobbying activities, plus allocable overhead. Treasury Regulation section 1.162-29 provides guidance on identifying lobbying expenses and the allocation methodology. Practitioners advising corporations with large government affairs budgets should implement a timekeeping protocol for all personnel who engage in any lobbying activity and should build the allocation calculation into the year-end tax provision process.

The interaction between lobbying disallowance and deductible business interest expense is addressed in our IRC 163(j) business interest limitation guide for practitioners managing ATI computations across entities with significant government affairs operations.

IRC 6033(e) Proxy Tax for Trade Associations

Trade associations and other tax-exempt organizations described in IRC 501(c)(4) (social welfare organizations), 501(c)(5) (labor unions and agricultural organizations), and IRC 501(c)(6) (business leagues and chambers of commerce) are required under IRC 6033(e) to notify their members of the portion of dues and similar payments that is allocable to lobbying and political activities. This notice requirement exists because member dues are deductible as ordinary and necessary business expenses under IRC 162(a) only to the extent they are not allocable to lobbying, which is disallowed under IRC 162(e).

Proxy Tax Mechanics

If a covered organization fails to provide the required notice, or provides an inadequate notice, the organization itself is subject to a proxy tax under IRC 6033(e)(2). The proxy tax equals the highest rate of tax imposed on corporations under IRC 11 (currently 21%) multiplied by the amount of lobbying and political expenditures for which notice was not provided. The proxy tax is the organization's liability, not the member's, and is paid in lieu of the member-level nondeductibility that notice would have enforced. The economic effect is that the organization bears a tax cost approximately equal to the tax cost the members would have borne had they correctly disallowed the lobbying portion of their dues.

Annual Notice Requirements and Reasonable Estimate Safe Harbor

To avoid the proxy tax, a covered organization must provide each member with a reasonable estimate of the lobbying and political expenditure percentage at the beginning of each year (or at the time dues are assessed). The organization may use a prior-year actual percentage as the basis for the current-year reasonable estimate. If the actual lobbying expenditure percentage for the year turns out to exceed the estimated percentage disclosed to members, the organization must provide a corrected notice. The safe harbor under Treas. Reg. sec. 1.6033-5T protects organizations that make a good-faith reasonable estimate and correct any shortfall through a timely supplemental notice before the close of the taxable year.

Interaction with Member Deductibility

A critical point practitioners frequently misunderstand: payment of the proxy tax by the organization does not make the lobbying portion of member dues deductible. Even when the organization elects to pay the proxy tax rather than provide the notice, the member's dues remain nondeductible to the extent allocable to lobbying under IRC 162(e). The proxy tax is a tax on the organization, not a clearance that converts nondeductible dues into deductible expenses. Members of trade associations that pay the proxy tax must still inquire about the lobbying allocation percentage and disallow that portion of their dues deduction.

IRC 274 and OBBBA 2026: Business Meal Deduction Changes

Pre-OBBBA Law

Under the Tax Cuts and Jobs Act of 2017 (TCJA), business meals remained 50% deductible under IRC 274(n), while the deduction for entertainment, amusement, or recreation was eliminated entirely. The 50% limitation applied to business meals whether incurred during business travel, in connection with client meetings, or provided by employers to employees. Employer-provided meals on the employer's premises for the convenience of the employer were also subject to the 50% limitation under TCJA's modifications to IRC 119. Before TCJA (under prior law), qualifying employer-provided meals meeting the "convenience of the employer" standard were 100% deductible; TCJA reduced that to 50%, with a scheduled phase-out to 0% after 2025.

OBBBA Change: Restoration of 100% Deductibility for Certain Meals

The One Big Beautiful Bill Act (OBBBA), enacted July 4, 2025, reversed the TCJA phase-out for certain employer-provided meals. For amounts paid or incurred on or after the OBBBA effective date, qualifying employer-provided meals that meet the "convenience of the employer" standard under IRC 119 are restored to 100% deductibility. The restoration applies to meals furnished on the employer's business premises for a substantial noncompensatory business reason, such as keeping employees available during a short lunch break, security requirements, or the absence of adequate eating facilities near the work site.

Which Meals Qualify for 100% vs. 50%

The following framework reflects the OBBBA position for tax year 2026:

• Employer-provided meals on business premises meeting the IRC 119 convenience-of-the-employer standard: 100% deductible (OBBBA restoration).
• Business travel meals (not employer-provided under IRC 119): 50% deductible under IRC 274(n).
• Client business meals with a documented business purpose: 50% deductible under IRC 274(n), subject to IRC 274(d) substantiation.
• Entertainment expenses (including meals where entertainment is the primary activity): Generally nondeductible under the TCJA entertainment disallowance, unless a specific exception applies. Practitioners should review whether OBBBA made any changes to the entertainment disallowance for the specific expense category at issue.
• De minimis fringe meals under IRC 132(e): 100% deductible for the employer as a business expense.

Verify applicable effective dates and the treatment of specific meal categories under OBBBA with current IRS guidance at IRS.gov before advising clients.

IRC 274(d) Substantiation: Strict Standard Unchanged by OBBBA

OBBBA modified the deductible percentage for certain meals; it did not change the IRC 274(d) substantiation requirement. For every business meal claimed as a deduction, the taxpayer must maintain contemporaneous written records establishing: (1) the amount; (2) the date and place; (3) the business purpose; and (4) the business relationship of each person present. The "directly related" or "associated with" test for business meal deductions requires that the meal have a clear business benefit beyond goodwill and that it occur in a clear business setting or directly precede or follow a substantial and bona fide business discussion.

IRC 162 vs. IRC 212: Business Expenses vs. Investment Expenses

IRC 162 applies to expenses paid or incurred in carrying on a trade or business. IRC 212 applies to expenses paid or incurred for the production or collection of income, for the management of property held for the production of income, or in connection with the determination or collection of any tax, where the activity does not rise to the level of a trade or business. The distinction matters because the two Code sections carry materially different tax consequences:

• IRC 162 business expenses are fully deductible above the line (reducing AGI), are included in the base for the qualified business income deduction (QBID) under IRC 199A, and are not subject to the miscellaneous itemized deduction floor.
• IRC 212 investment expenses for individuals were miscellaneous itemized deductions subject to the 2% AGI floor under pre-TCJA law. TCJA suspended the deduction for IRC 212 expenses (other than expenses related to the determination of tax) for tax years 2018 through 2025. Whether OBBBA restored IRC 212 deductibility for 2026 and beyond is a separate question practitioners must verify with current statutory text and IRS guidance.
• AMT treatment also differs: IRC 162 expenses reduce AMT income; IRC 212 miscellaneous itemized deductions were an AMT preference item under prior law.

The trade-or-business versus investment-activity line is particularly significant for real estate investors, rental property owners, and commodity traders. In each of those contexts, whether the level and regularity of activity crosses the threshold from IRC 212 investment activity to IRC 162 trade or business activity determines the deductibility treatment of expenses and losses.

IRC 162 Business Expense Deductibility Reference Table

Compliance Traps: IRC 162 Examination Flash Points