November 3, 2021
How-to

Business expense categories list & tips to maximize deductions

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Tax season can make you feel like you’re drowning in a sea of missing documentation and buried under unruly piles of expenses when there’s no structure in place to wrangle and report them. As if internally managing the finances for a small business or startup isn’t hard enough, now you have to think about what an external entity requires. It’s enough to make a grown person cry.

Enter business expense categorization to save the day. Topics included in this article:


What are business expense categories?
How to set up your business expense categories
Common business expense categories
How to categorize your expenses to maximize tax deductions
How to make sure expenses are categorized correctly
Get back your time and money during tax season with Ramp

What are business expense categories?

Business expense categories are classifications that you can use to organize your expenses to inform internal financial control and tax filings. For example, if your company paid for airfare for a business trip, you may categorize that as a “travel” expense. And, because it is categorized as such, certain transaction details and documentation would then be required so you can write it off come tax time.

Some examples of business expense categories include:

  • Payroll 
  • Employee benefits
  • General and administrative expenses
  • Marketing and advertising spend
  • Research and development spend
  • Payments for professional services

Trying to go back and categorize your expenses at the end of the year is a sure way to lose valuable time and money. Instead, categorize and map your expenses in advance. You’ll make it easier to do reporting and save the maximum amount in business tax deductions.

How to set up your business expense categories

Looking at the extensive list of IRS business expense categories can feel overwhelming, but the good news is you don’t have to have every one of those exact categories to stay in compliance and save money come tax season.

The key is to set up categorization that reflects your internal company structure, e.g. by department, and spend management needs. Just make sure to include enough detail and documentation to easily pull reports that satisfy IRS compliance.

For example, expenses may be classified by type, like “General and Admin” and “Research and Development” (R&D), and then sorted by department, like “Marketing” and “Engineering.” So, when an engineer in the company buys a special software for building new products, the expense is categorized as an R&D expense, incurred by the Engineering Department and attributed to that department when sorted.

Source

It’s worth noting that you likely will need more granular categories for internal P&L statements than you will for IRS categorization, but to make your life easy, those more granular categories should each fit into one of the IRS categories.

No need to overcomplicate classifying different types of expenses, though. Keep categories general and limit the number of general ledger (GL) accounts you have. Use custom fields to capture the “who, what, where, and why” of each transaction, so they can be easily sorted or reclassified for different reports as needed.

For example, for internal purposes, you may only need to know that an employee made a meal purchase, but if you want to deduct the expense as a business meal come tax time, you will need to know if the employee ate alone, with a team, or with a client, and what was discussed. You may not need an entire category for each of these details, but defining transaction details in your spend management platform can make reporting and increasing tax deductions much easier. Noting how many people were at the meal and what was discussed, for example, can mean the difference between an “individual meal” that is only 50% deductible versus a “team event” that is 100% deductible.

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List of common business expense categories

Not sure where to start with creating business expense categories? Here are a few common ones, but again, tailor these to your own company’s structure.

Payroll and Employee Benefits

  • There are employee-related expenses that include: employee health insurance
  • retirement plans
  • bonuses
  • paid vacations.

General and Admin

This includes regular operating expenses such as: 

  • office supplies (i.e., computers, printers, pens)
  • rent and leases
  • cleaning services for the office space
  • transportation
  • meal stipends
  • other office expenses

Marketing and Advertising

These are costs that cover the promotion of your business:

  • Social media ads
  • marketing consultants
  • contracted marketing services
  • business cards

Research and Development (R&D)

These are expenses incurred in the process of building a product, including:

  • Software subscriptions
  • product testing equipment

Professional Services

These cover the professional fees of external consultants and contractors:

  • Contracted designers and recruiters
  • legal fees
  • CPA services

How to categorize expenses to maximize tax deductions

To optimize your expense categories for business tax deductions, it’s important first to understand what is deductible and what documentation is needed for compliance when claiming expenses on your tax return and filing small business taxes.

Your source of truth for this is IRS publication 535, which dictates what is deductible or not. According to this document, an expenditure is considered deductible if it can be proven “ordinary and necessary” for business purposes.

For example, you can usually count a business luncheon with a prospective client as ordinary and even necessary to cultivating business. However, that embarrassingly large pizza order you placed for just yourself while you ate your feelings over the weekend may not be so necessary or ordinary to your business growth and can't be considered a write-off.

Deductible business expenses list

What counts as deductible business expenses will depend on your particular business structure, but this list includes the major expense categories that are deductible per the IRS:

Deductible expense category
Details
  • Cost of goods sold: This is deducted from your gross receipts to find your gross profits for the year. Note, you cannot deduct the cost of calculating the cost of goods sold.
  • Capital expenses
    • Startup costs
    • Repairs or maintenance to the business property
    • Business assets
  • Not-for-profit activities and charitable contributions
  • Business travel expenses
  • Awards
  • Bonuses
  • Education benefits
  • Fringe benefits: While fringe benefits are deductible for the employer, they are taxable for the employee, so when categorizing these expenses, make sure to categorize them as “fringe benefits” and map them to the correct GL accounts so the amounts are easily added to W2s.
  • Loans or advances
  • Property (such as company stock)
  • Business expense reimbursements
  • Sick and vacation pay
If you will receive equity in the property or a title of any kind, the rent is not deductible.
  • Taxes on leased property
  • Improvements by lessee
  • Cost of getting a lease
  • Home office expenses
  • Business use of your car
  • Personal cell phone used at least 50% of the time for work
  • Depreciation of personal property being used for your business
  • Property taxes
  • State and local income taxes
  • Foreign income taxes
  • Employment taxes
  • Other miscellaneous taxes

Each of these categories has precise requirements for deduction and is subject to change at the discretion of the IRS. So it’s a good idea to subscribe to IRS e-News alerts, review the “recent developments” section of the IRS publication 535 regularly, and work closely with a tax advisor to maximize deductions.

Taking the time at the start of each tax year to optimize your expense categories and map to ledgers based on IRS changes will make tax season significantly smoother.

For example, for internal purposes, you may only need to know that an employee made a meal purchase, but if you want to deduct the expense as a business meal come tax time, you will need to know if the employee ate alone, with a team, or with a client, and what was discussed. You may not need an entire category for each of these details, but defining transaction details in your spend management platform can make reporting and increasing tax deductions much easier. Noting how many people were at the meal and what was discussed, for example, can mean the difference between an “individual meal” that is only 50% deductible versus a “team event” that is 100% deductible.

Tip from Edwine Alphonse, our Finance Controller at Ramp: "By being intentional about your naming conventions and the categorizations, you'll make sure you're complying with IRS rules, in terms of documentation. You’re also making your life easier when it’s time to do your tax filing or going through your year-old closing checklist.”


Non-deductible expenses

Some expenses you want to watch out for that are not tax deductible include the following:

Non-deductible expense category
Details
These are considered assets in your business, so they must be capitalized rather than deducted.
  • Business startup costs
  • Business assets
  • Improvements to business property: While generally, these expenses are not deductible, some of them may fall under special provisions and can be recouped through amortization deductions.
  • Self-insurance reserve funds
  • Loss of earnings
  • Certain life insurances and annuities
  • Insurance required to secure a loan
Federal income taxes


How to make sure expenses are categorized correctly

So, you’ve determined categories that align with your internal finance needs and IRS compliance, but you’re still faced with actually enforcing categorization. Manually processing expenses has proven unreliable and time-consuming, so how do you ensure expenses are consistently and correctly categorized?

Use expense management software

Startup and small business expense management software automates expense mapping and categorization with customizable fields, prompts for required documentation, and integrations with bookkeeping software.

Gathering all of your expenses in a central software where every expense process can take place provides a clear audit trail and easy reporting.

With every transaction in one platform, it’s easy to pull a report for a single expense category across all departments and GLs and then sync with bookkeeping and tax-filing software.

Ramp's accounting dashboard


Automate workflows

Expense management software that's built into modern corporate credit cards and charge cards adds an additional layer of data control by providing customized card controls that inform every step of the transaction.

Custom no-code workflows provide consistent expense documentation by prompting employees throughout the transaction process. When a transaction occurs, employees are immediately prompted via SMS or email to submit documentation.

Ramp's automated receipt matching

Once documentation is submitted, automated receipt matching ties it to the corresponding expense and prompts the employee to fill in required details in customizable fields. The expense management software then uses automation and AI to categorize the expense and sync the information with your accounting software.

Get back your time and money during tax season with Ramp

Tax season doesn’t have to be stressful, and saving time and money shouldn’t be that complicated, even if you’re a small business owner or startup founder without a big finance department.

With Ramp’s powerful finance automation and AI behind your business expense categorization, tax season is just another day at the office. You can pull comprehensive reports with a single click and then sit back with a cup of coffee and watch your tax return grow. Learn more about how we are saving our customers an average of $100k in their first year using our software.

The information provided in this article does not constitute legal or financial advice and is for general informational purposes only. Please check with an attorney or financial advisor to obtain advice with respect to the content of this article.

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FAQs
What are the benefits of categorizing expenses?

Two big benefits of categorizing expenses are avoiding legal trouble and ensuring your business isn’t overpaying come tax time. Seeing which business expenses are allowable, and knowing what you spend money on is the first step to benefiting from expense categorization.

How do small businesses categorize expenses?

The same way any business would categorize expenses: by keeping track of what they spend money on, why they’re spending money on it, and checking IRS documentation to see if those qualify as business expenses. Ramp’s expense management and tracking capabilities can make a big difference when you want to maximize deductions and analyze spending habits.

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