What are business expenses? Definition, examples, and tips

What are business expenses?

Business expenses include the cost of goods and services, money spent establishing your business, and daily operational expenses and other costs.

These costs are deemed tax-deductible by the Internal Revenue Service (IRS) if they fall into the category of “ordinary and necessary” for your business type. Some examples of common business expenses are:

• Advertising and marketing expenses
• Employee payroll and commission
• Office supplies
• Storage fees

In this guide, we’ll thoroughly explain the IRS’s definition of a business expense, differentiate between personal and business expenses, review common business expenses, and share some best practices for staying on top of tracking business expenses.

The IRS’s definition of a business expense

Because business expenses are tax-deductible, it’s important to understand exactly how the IRS defines them. The IRS states that business expenses must meet two criteria before you can write them off on your taxes:

1. Ordinary: Common expenses for businesses in your industry
2. Necessary: Expenses needed to operate your business, even if they aren’t indispensable

If you find yourself thinking all your business expenses meet those criteria, you’re not alone. These guidelines basically stop you from writing off capital expenses, personal expenses, and expenses used to figure the cost of goods sold (COGS).

Business expenses vs. personal expenses

Many small business owners and entrepreneurs struggle to separate certain business expenses from personal expenses. This issue becomes even muddier if you’re self-employed. However, there’s one question you can ask yourself to make the distinction:

Did this expense further my business or benefit me personally?

If you spent money for any business purpose, and what you purchased serves a business use, it’s a business expense. If an expense benefited you personally and professionally, then you can split it between business and personal expenses. Tracking business expenses becomes much easier when the separations between business and personal are very clear.

Take your cell phone as an example. You may have one phone that you use for business and personal purposes, splitting the bill between those expense categories. If you can secure a separate phone that you use only for business purposes—even if you’re self-employed—then the full bill for that phone becomes a business expense.

The same goes for utilities and other expenses for a home office that are shared with the household in general.

Types of business expenses

If you listed every business expense related to your company, how many categories could you split them into? There are so many business expense categories that it’s impossible to list them all in one place. Some are industry-specific, and you may even have some that are unique to your company.

That’s why income statements are useful. These documents summarize all taxable income and expenditures for a business within a given timeframe. You can use an annual statement to get a good picture of your company’s financial performance for one year. It’s helpful for calculating profits and losses for tax purposes as well.

To simplify this, there are three primary categories of business expenses used for business income statement reporting. Let’s look at each of them, along with some examples of expenses that may fall into each category.

Direct costs

These are expenses required to produce goods and services for your customers. Everything from the cost of raw materials to labor costs may fall into this business use category. It's important to note that the expenses used to determine the cost of goods sold cannot also serve as individual deductions.

Indirect costs

These are essential expenses that aren’t directly related to the production of products and services. You may include everything from advertising expenses to compensation for your executives in this category.

Depreciation

This category considers the depreciation of business assets over time. The equipment you use to produce your products, the computers you use in your office, and your fleet of business vehicles may all fall into this category.

Examples of common business expenses

As we reviewed above, the IRS dictates that a business expense must be ordinary and necessary for you to write it off on your taxes. Here are some common business expenses that meet those criteria:

• Advertising and marketing expenses
• Business travel and related travel expenses
• Employee payroll and commission
• Depreciation of equipment, vehicles, and more
• Office supplies and other work-related equipment like electronics
• Rent and mortgage payments for office space
• Property maintenance, restorations, and improvements
• Interest

Whether these expenses are considered direct, indirect, or depreciation expenses varies. The IRS provides extensive guidelines to help you determine how to write off a variety of business costs.

On the other hand, here are some business expenses that don’t meet the IRS’s criteria and thus aren’t tax-deductible:

• Penalties, fines, and legal fees
• Worker's compensation insurance
• General liability business insurance premiums
• Cost of commuting
• Residential space not used exclusively for business purposes
• Political or charitable contributions
• Client entertainment
• Clothing for business events

5 tips for managing business expenses

Keeping on top of business expenses can be challenging. Luckily, there are some fairly straightforward ways to make the process go a little smoother. Consider these five tips:

1. Document your expenses

Get in the habit of documenting expenses and securing receipts immediately for proof of purchase. The longer you wait, the more likely you are to forget some expenses or place them in the wrong categories. Moreover, keeping meticulous records will be a lifesaver if you ever get audited: the IRS requires that you keep some types of records for several years.

2. Keep personal and business expenses separate

If you plan to deduct business expenses on your taxes, make sure every expense was used fully for business purposes. If an expense was partially for personal gain, you can't deduct the full expense from your taxes.

3. Learn which expenses are tax-deductible

Study the various expenses that can lower your tax obligation. Even little things like paper for the printer or that new ergonomic office chair are fair game. If you don't have a tax expert on staff, consider consulting with one to help find all the business expenses you can claim on your taxes.

4. Ease the burden with software

Minimize or eliminate human error by working with professional expense management software. Better yet, start using a corporate credit card to separate work-related expenses from personal ones.

5. Monitor your expenses regularly

Modern software solutions allow you to track your business expenses in real time using charts, dashboards, or other reports. If you choose to track your expenses manually, build reviews into your expense management policies right from the start. Regular reviews will go a long way toward helping you catch errors and prevent expense fraud.

Manage your business expenses with Ramp

With so many possible tax credits and deductions, it's important to properly document, track, and report all your business expenses. From the smoothie you purchased for your favorite client during a business meeting to the flight you took for an important meeting, every expense counts.

If you want to simplify the process of tracking expenses and cut out human error, add Ramp's expense management software to your team. Our modern platform makes it easy for all your employees to record and send in copies of receipts, and our tracking features lets you monitor your expenses in real time.