Any company will have business expenses. Meticulously tracking them ensures you know whereyour funds are going, and it helps you reduce your tax liability. It’s also crucial tounderstand what business expenses are and what you can deduct so you're not paying moretaxes than necessary.
What Are Business Expenses?
According to the Internal Revenue Service (IRS), business expenses are ordinary and necessarycosts incurred to operate your business. Examples include inventory, payroll and rent. Fixed expensesare regular and don’t change much — things like rent and insurance. Variableexpenses areexpected, but they can change. Some examples include sales commissions, gas for businessvehicles and shipping costs. You expect variable expenses each month, but the actual amountwill vary. Tracking your business expenses helps you keep an eye on whether you’ll seeprofits or losses.
Key Takeaways
- Business expenses need to be considered ordinary and necessary for them to betax-deductible.
- Business expenses are recorded on an income (profit and loss) statement.
Business Expenses Explained
Also referred to as deductions, business expenses are thecosts of operating a business. They’re recorded on the income statement. Theseexpenses willbe subtracted from business revenue to show a company's net profit or loss and taxableincome.
Guidelines for business expenses can be found in Section 162 of the Internal Revenue Code(IRC). As long as an expense is considered ordinary and necessary, it can be reported to theIRS to help reduce tax liability.
According to the IRS, ordinary refers to expenses common to most business owners in theindustry or trade. Necessary means your expenses help with your business operations, andthey're appropriate to your organization.
How Do Business Expenses Impact or Reduce Taxes?
Any expense that meets the IRS definition of ordinary and necessary can be deducted. To bewritten off, an expense needs to be incurred by a business intending to make a profit. Someexpenses may be fully deductible, whereas others are partially deductible or won’t befullydeducted the year they’re incurred.
What Are Examples of Deductible Business Expenses?
The following business expensesmay be fully or partially deductible:
- Advertising and marketing
- Bank fees and interest
- Business mileage
- Commissions
- Educational expenses for employees
- Employee benefits
- Equipment maintenance and repair
- Furniture
- Home office (you’ll need to meet certain requirements such as that it is your mainplaceof business)
- Insurance
- Membership dues (business-related expenses only)
- Legal fees
- Office supplies and equipment
- Payroll (employees and contractors)
- Rent or office lease
- Mortgage payments
- Software
- Some costs of business travel
- Utilities
What Are Examples of Non-Deductible Business Expenses?
Not all business expenses are tax-deductible.
Here are some examples:
- Demolition expenses or losses
- Educational expenses incurred to meet requirements to conduct business
- Government fines and penalties
- Illegal activities
- Lobbying expenses
- Political contributions
Also note that capital expenditures, while deductible, are typically written off over severalyears through an accounting process known as depreciation.
Income Statement Reporting
Your income statement is the main financial statement used when recording business expensesand determining your taxable income. The income statement shows a picture of yourcompany’sexpenses and revenues over a given period of time. The statements are typically broken intodifferent categories.
Costs of Goods Sold (COGS): Also known as cost of sales, COGS referto the cost of manufactured or purchased goods sold. COGS are a business expense andaffect how much profit a company makes on its products. It's deducted from abusiness's total revenue to determine gross profit and can include factory overhead,storage, cost of raw materials and parts used to make a product, direct labor costs,shipping or freight in costs and indirect costs, such as distribution or sales forcecosts.
Operating Costs: Operating costs areany expenses associated withthe day-to-day maintenance and administration of a business. Operating costs includefixed, variable and semi-variable costs. These expenses are subtracted from grossprofit to find operating profit and typically include marketing costs and executivecompensation. Gifts and meals would also fall under this category.
Depreciation: Depreciation is theprocess of deducting the cost of abusiness asset over a long period of time, rather than over one year. Depreciationhas two main components: one is the decrease in the value of an asset over time andwhen you allocate the price you originally paid for an asset over the period of timeyou use that asset. Generally Accepted Accounting Principles (GAAP) requires thatcompanies use standard depreciation methods with specific depreciation schedules forvarious asset categories. Amortization is similar to depreciation, but is a methodof spreading the cost of an intangible asset over a specific period of time.
Interest expenses: Interest paid on loans is subtracted from taxableincome.
Personal vs. Business Expenses
Business expenses can be deducted to lower your company’s overall taxable income.Personalexpenses cannot. So, what are some of the differences and is there ever a gray area?
Personal expenses: It’s vital that you keep your personal expensesseparatefrom business. For example, if you go to the hardware store to buy some lumber for apersonal project and throw in some industrial cleaner to scrub the floors of your store, besure to run two transactions. That way you can keep separate receipts and if you have abusiness credit or debit card, you can use that for the business purchase.
Business expenses: Are you making a purchase to try and drive more revenueto your business? Is it something that would be considered a normal purchase in yourindustry? It’s likely a business expense. Record the purchase, store the receipt andrecordthe reason for the purchase. The amount can be deducted from your income and lower your taxliability. Large expenses that increase the long-term value of your business like buying newequipment or investing in a new building are considered capital expendituresand are handled differently thanother expenses.
Key differences: Business purchases are things you buy in the normaloperations of your business. Personal expenses are items that do not pertain to yourbusiness. But what about things like home offices? If you use an office out of your homeprimarily for business purposes, you may be able to write off that expense. But youwon’t beable to deduct the entire price of your home mortgage. There are occasions when you canitemize certain aspects of expenses like utilities, real estate taxes or phones. It’sespecially important for you to keep meticulous records that detail why you’reexpensingthese items, in case you are ever audited.
Top 6 Business Expense Tips
Staying on top of your business expenses can be overwhelming. But it is also one of theeasiest ways to reduce your overall tax liability. Here are some tips to make expensemanagement a little easier.
Keep meticulous records.
When in doubt, keep it. Not only will receipts and other documentation of yourbusiness expenses come in handy if you’re ever audited, the IRS requires somerecords be kept for up to 7 years. Things like receipts, tax returns and employmentrecords need to be kept for 3-4 years. And documentation of writing off bad debtshould be kept for 7 years. Consider using business accounting software to trackyour expenses and go paperless for record keeping.
Separate personal and business expenses.
Business expenses can be written off and reduce your overall tax liability. Startseparating your business and personal expenses right away. Open a separate businesschecking account. Get a businesscredit or debit card. And make sure your business partners know whichexpenses can be written off, and which can’t.
Brush up on what expenses are considered taxdeductible.
Not all expenses are tax deductible. But most expenses you incur while trying todrive revenue to your business can be written off. Some major purchases like largeequipment are considered capital expenditures. The initial purchase may not bewritten off all in one tax year, but the depreciation of value, along with the costsof running it would be.
Save receipts for business travel.
Many business travel expenses are tax deductible. Keep records of costs liketransportation, lodging and some of the meals (usually 50% of the cost.) Keep yourreceipts for these expenses for at least three years, as long as the IRS can audityou.
Record expenses as soon as possible.
Whether you store your records yourself or use a business accounting softwareprogram, get in the habit of recording expenses right away. Formalize the processfor how you track and store the receipts and record expenses.
Monitor and review expenses regularly.
Business accounting software can display your expense information with charts anddashboards. And if you track your expenses manually, be sure to build regular reviewinto the expense managementpolicies and procedures. Consider double-entry bookkeeping to catch errorsand prevent fraud.
How to Track Business Expenses?
Tracking yourbusiness expenses should become a habit. By making it part of your regular workflow,you’reless likely to miss expenses that can reduce your overall tax burden. And by keeping an eyeon your expenses and revenue through your income statement, you’re able to bettermonitorthe financial health of your company.
Open a business bank account. Make sure this is separate from yourpersonal checking account and only use it for business expenses. This will make iteasier to track your business charges. And you may be eligible for business creditor debit cards that come with perks like cash back or no-interest financing forthree months.
Formalize how you store receipts. Consider scanning receipts andkeeping digital copies. Try and make it part of your regular workflow. If not daily,try to set aside the same time each week to scan and organize receipts. Write thebusiness purpose on the receipt so you can remind yourself later, if needed.
Review and categorize your expenses regularly. Examine eachtransaction and track your spending by category. By comparing your expenses torevenue, you can see how much it costs to produce an amount of revenue in a giventime.
Consider buying business accounting software. Save time and ensureyou have the most up-to-date information with an accounting platform. Store andtrack receipts and easily categorize expenses. You can see charts and dashboards ofyour financial information, as well as generate important reports, like the incomestatement.
Tracking Business Expenses With Software
By tracking your expenses, you can reduce your tax liability. But it’s also importantto keepdetailed records of these expenses in case you’re audited or need to reconcileaccounts.Going paperless and using business accountingsoftware can help save time, automate processes and keep more accurate financialrecords, even if you have a small business or startup. As your business grows, the softwarewill scale with your growth. And top-tier cloud solutions like NetSuite integrate with otherbusiness software, such as your CRM, inventory management and ecommerce functions.
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Business Expense FAQs
Can business expenses be carried forward?
Your business may be able to take a carryforward if you have a net operating loss (NOL),you're over the amount of deductions allowed and a nonrefundable credit you qualify for ismore than the tax you owe in a year.
Business expenses that can be deducted are not taxed. There are a few business expenses likedemolition that cannot be written off.
Can I deduct personal expenses for business?
You cannot deduct personal expenses for your business. However, if the expense is for bothbusiness and personal use, you may deduct the business portion. For example, let’s sayyouhave a vehicle and drive to consult with on-site clients 25% of the time. You can deduct 25%of your business expenses. You’ll need to keep records such as mileage incurred,maintenancecosts and the purpose of each trip.
What are the three types of business expenses?
The three major types are:
- Fixed: These expenses tend not to change and remain the same. Examplesinclude rent or equipment lease payments.
- Variable: These expenses change from month to month. Examples includeemployee commissions and utilities.
- Periodic: These expenses happen occasionally. Examples includeemergency equipment repairs and annual bonuses.
