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:
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:
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.
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.
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.