What are business expenses?
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The simplest definition of a business expense is the cost of goods and services required to operate. That includes money spent establishing your business as well as daily operational expenses and other costs.
This guide will explain what's considered a business expense by the IRS while exploring what you can and can't deduct at tax time.
What are business expenses?
Business expenses are the costs required to establish a company, produce goods and services, and distribute them to paying customers. Anything that you spend money on in the name of doing business can be categorized as a business expense. Whether the IRS considers it a legitimate expense that you can write off on your taxes is another story, however.
The IRS’s definition of a business expense
The IRS states that business expenses must meet two criteria before you can write them off on your taxes:
- Ordinary: common expenses for businesses in your industry
- Necessary: expenses needed to operate your business, even if they aren’t indispensable
If you’re thinking that every business expense you have meets 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.
We’ll discuss how you write business expenses off your taxes in a moment. For now, let’s dig into a distinction that every business owner and entrepreneur must learn to make: business expenses vs. personal expenses.
Business vs. personal expenses
If you’re like many small business owners and entrepreneurs, you may struggle to separate different types of business expenses from personal expenses. 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, it’s a business expense. If an expense benefited you personally and professionally, then you may split it between business and personal expenses. Tracking expenses becomes much easier when the separations between business and personal are very clear.
Take your cellphone 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, then the full bill for that phone becomes a business expense.
To make things more clear, let’s discuss the different types of business expenses and how you can write them off to reduce your tax burden at the end of the year.
What are the 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 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 income statement reporting. Let’s look at each of them along with some examples of expenses that may fall into each category.
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 category. It's important to note that the expenses used to determine the cost of goods sold cannot also serve as individual deductions.
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.
This category considers depreciation of business assets over time. The equipment you use to produce your products, computers used in the office, and your fleet of business vehicles may all fall into this category.
Deductible business expenses
As mentioned, the two criteria that the IRS uses to determine whether you can write a business expense off on your taxes are that it must be "ordinary" and "necessary".
Some examples of business expenses that are deductible include the following:
- Advertising and marketing expenses
- Employee payroll and commission
- Depreciation of equipment, vehicles, and more
- Business bank fees
- Office supplies
- Electronics (computers, tablets, phones, etc)
- Food for business events
- Startup costs
- Storage fees
- Pension and annuity plan contributions for employees
- Factory overhead
- Rent and mortgage payments
- Administrative costs
- Property restorations and improvements
- Property routine maintenance
- Work vehicle repairs, maintenance, mileage
- Replacement parts for machinery
- Upgrading or repairing heating equipment
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.
Non-deductible business expenses
You can't deduct personal expenses from your business taxes. That includes expenses related to your personal household and family, unless a portion of those expenses was used for business purposes. In that case, you would deduct only the business-related portion of the expense.
For example, say you purchase a case of cleaning solution for your home. You have an office dedicated to business in your home, and half of the cleaning solution is used for the office exclusively. You may write off half the cost of the cleaning solution case, since that was the portion used for business purposes.
The same goes for utilities and other expenses for a home office that are shared with the household in general. You can't fully deduct an expense unless it's used entirely for business purposes.
Other business costs that aren't deductible include the following:
- Penalties and fines
- Legal fees
- Worker's compensation insurance
- General liability insurance
- Capital expenses that benefit your business for more than one year (you may deduct depreciation)
- Cost of commuting
- Residential space not used exclusively for business purposes
- Political or charitable contributions
- Client entertainment
- Clothing for business events
How to write off business expenses
Expense deduction is a critical part of filing taxes for your business. Whether you operate as a sole proprietor, LLC, or other business structure, there are two options:
- Write the entire expense off in the year it was spent. If you purchased $5,000 in office supplies over the course of the year, you would enter that full amount on your taxes for deduction.
- Write the expense off over the lifetime of the purchase. You do this as depreciation for purchases that will benefit your business for more than a year. Vehicles and expensive equipment often fall into this category. Instead of deducting $25,000 in a single year for a new work truck, you would deduct depreciation of that truck for a number of years.
Either way, it's important to keep track of all deductible business expenses. That includes keeping receipts as proof of purchase. Accounting management software makes that easier than ever, and we'll talk more about that in a moment.
Tips for tracking business expenses
- Get in the habit of documenting expenses and securing receipts immediately. The longer you wait, the more likely you are to forget some expenses or place them in the wrong categories.
- 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.
- 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 find all your tax deductions.
- Minimize or eliminate human error by working with professional expense management software. More on that below.
Manage your business expenses with Ramp
With so many possible tax 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 and cut out human error, put Ramp's expense management software to work for your company. We make it easy for every member of your team to send in copies of receipts plus memos that explain every swipe of their business card. Our AI-powered software also detects duplicated receipts and help you flag purchases that are potentially unauthorized.
Keep all your accounting records in one secure place and monitor spending trends over time. You can do it all with Ramp.