Every dollar counts. You carefully watch your cash flow to minimize costs and maximize profits.
But despite your best efforts, there always seem to be unexpected expenses popping up.
Here’s the thing: Not all expenses are created equal.
Some are tax-deductible, which means you can subtract them from your taxable income and reduce your overall tax bill.
That’s where understanding business-expense categories becomes crucial.
This comprehensive guide will walk you through everything you need to know about business-expense categories.
We’ll explain what business-expense deductions are, what expenses might be tax-deductible, and how you can track and categorize your expenses using accounting software.
This guide will help you make sense of your expenses and take control of your finances.
So, let’s dive in!
What are business-expense deductions?
Business-expense deductions refer to expenses incurred during operations, which can be subtracted from your taxable gross income to lower your tax liability.
According to the IRS, business expenses must be ordinary and necessary to be deductible.
Ordinary expenses are common and accepted in your relevant industry, while necessary expenses are helpful and appropriate for your business.
These publications cover the general rules for deducting business expenses, specific expenses you can deduct, and forms you may need to fill out.
Do you want to take advantage of all available tax deductions for expenses?
Then it’s important to keep accurate records of all expenses with accounting software and to consult with a tax professional or accountant.
Common types of business expenses and their definitions
Various types of business expenses could be deductible, including but not limited to:
Office expenses refer to the costs of running an office and keeping it operational. Certain office expenses may be tax deductible. This includes expenses related to:
- Office supplies
- Legal fees
Utility expenses are the costs of providing necessary utilities to operate a physical space. Potential tax-deductible utility expenses include:
- Phone services
Tax-deductible utility expenses must be directly related to your business or rental property, not personal. The amount you can deduct varies depending on the utility type and the percentage of its use for business or rental purposes.
There are certain exceptions. According to the IRS, if you use a portion of your home for business purposes, you may be able to deduct a percentage of your home utility expenses, such as electricity, heating, and water, as a business expense.
Equipment expenses refer to the costs associated with purchasing, leasing, or renting equipment for a business. These expenses include a wide range of equipment, such as machinery, vehicles, computers, and office furniture.
Machinery equipment includes:
- Manufacturing machines
- Construction equipment
- Other equipment used in production processes
Vehicle equipment includes
- Other vehicles used for transportation or delivery purposes.
Computer equipment includes
- Other technology you might use to run a business
Office furniture includes:
- Other furniture you or your people might use in your working space
Tax-deductible equipment expenses depend on the type of equipment and the amount spent on it. Generally, you can get a tax deduction if you use the equipment for business purposes.
Travel expenses refer to the costs incurred when travelling for business purposes. These expenses include transportation, lodging, meals, and other incidental expenses.
Transportation expenses can include:
- Rental cars
- Mileage reimbursement if an employee uses their personal vehicle
Lodging expenses include:
- Hotel or motel stays
- Meals and tips
- Other expenses incurred on a business trip.
Here are 4 things to remember about travel expenses:
- You may want travel policies to govern how much employees can spend on travel expenses and what expenses are reimbursable.
- Travel expenses can add up quickly, particularly if your business requires frequent travel. As a result, it’s essential to track and manage these expenses carefully.
- You can use travel expense tracking tools or software to monitor expenses and ensure they stay within budget.
- For travel expenses to be tax deductible, they must be primarily related to a business purpose and not personal.
Insurance expenses refer to the costs associated with purchasing insurance to protect your business from various risks and liabilities.
These expenses can include a wide range of insurance policies, such as
- Liability insurance
- Property insurance
- Workers’ compensation insurance.
Liability insurance can protect you from lawsuits and claims related to injuries or damages caused by your business or its employees.
Property insurance can protect your business from losses due to theft, fire, or other property damage. Workers’ compensation insurance can protect from claims related to injuries or illnesses employees suffer on the job.
Not all insurance expenses are tax-deductible, and the rules can vary depending on the country or region.
The US has specific guidelines and limitations for deducting insurance expenses. Consult with a qualified tax professional or accountant to ensure compliance with the relevant tax laws.
Advertising and marketing
Advertising and marketing expenses refer to the costs of promoting your products or services to potential customers.
These expenses can include a wide range of activities, such as
- Print and digital advertising campaigns
- Sponsorships and trade shows
- Public relations efforts
Marketing expenses can increase quickly, particularly if you operate in highly competitive industries. As a result, it’s essential to track and manage these expenses carefully.
The IRS states that your business can deduct expenses that help you bring in new customers and keep existing ones, which may include expenses for advertising and marketing.
Professional services expenses refer to the costs of hiring outside experts to provide specialized services to your business.
These expenses can include professional services such as legal, accounting, consulting, and IT services.
- Legal services can include legal advice, contract drafting, and other legal services necessary to run a business.
- Accounting services can include bookkeeping, tax preparation, and financial reporting.
- Consulting services can include management consulting, marketing consulting, and other specialized services to help a business operate more efficiently.
- IT services can include website development, software development, and other technology-related services.
Some professional services expenses may be considered tax deductible.
According to the IRS, for example, you can deduct fees paid to attorneys, accountants, and other professionals who provide services that help conduct your business.
A reminder that expenses must be ordinary and necessary—common, accepted in the industry, and helpful and appropriate for your trade or business.
It is important to note that certain legal fees, such as those incurred in connection with the purchase or sale of property, may not be deductible but may be capitalized and included in the cost of the property or business.
What else can you deduct as a business expense?
You might choose to make charitable donations part of your corporate social responsibility initiatives, which can help to attract new kinds of customers and employees.
When making charitable donations, it is important to understand the potential tax implications.
According to the IRS, you can deduct charitable contributions made to qualified organizations, such as:
- Non-profit organizations
- Religious organizations
- Certain educational institutions
It is important to note that the amount of the donation you can deduct may be limited, depending on the organization and the type of donation.
For example, the deduction for a donation of property may be limited to the property’s fair market value. In contrast, the deduction for a cash donation may be limited to a percentage of the business’s taxable income.
However, you can carry any donation that exceeds the limit to future tax years. Keep accurate records and receipts of these donations.
Education and training expenses
Education and training expenses can be deductible as a business expense if they are directly related to your business or trade or required by law or condition of employment.
This can include expenses for
- Other educational programs maintaining or improving the skills and knowledge needed to run a business
For example, you may be able to deduct the cost of attending a marketing strategy conference or taking an accounting or financial management course.
Similarly, an employee could deduct the cost of continuing education courses required to maintain a professional license or certification.
It’s important to note that education and training expenses are subject to certain limitations and restrictions.
As you know, tax-deductible expenses must be reasonable and necessary.
You cannot use them to qualify for a new trade or business—that may be deductible as a capital expense, subject to different rules and limitations.
By deducting education and training expenses, you can invest in your people and improve their skills and knowledge while reducing your tax liability.
Health insurance premiums for self-employed individuals
Health insurance premiums for self-employed individuals can be deductible as a business expense under certain conditions.
To qualify, the individual must not be eligible for coverage under an employer-sponsored health plan. The insurance plan must be established for the individual or their self-employed business.
Self-employed individuals may be able to deduct the cost of health insurance premiums for themselves, their spouses, and their dependents.
The deduction is taken on the individual’s personal-income tax return as an adjustment to income, which means it is available even if the individual does not itemize deductions.
It’s important to note that there are limitations and restrictions on deducting health insurance premiums.
The deduction cannot:
- Exceed the individual’s net income from the business.
- Be taken for any month the individual was eligible for coverage under an employer-sponsored health plan.
- Be available for any month in which the individual was eligible to participate in a subsidized health plan maintained by an employer of the individual’s spouse.
Retirement-plan contributions can be a valuable tax deduction for businesses, allowing owners and employees to save for retirement while reducing tax liabilities.
Several retirement-plan types are available to businesses, each with its contribution limits and tax benefits.
According to the IRS, contributions to a traditional 401(k) or IRA plan are tax deductible up to certain limits. The amount that can be deducted depends on the type of plan and the individual’s income.
In addition to the potential tax benefits, contributing to a retirement plan can help your people save for their future and ensure financial security in retirement.
You might want to offer matching contributions to their retirement plans, which can further increase the funds they save for retirement.
It is important to keep accurate records and receipts of retirement plan contributions, as they may be subject to audit by the IRS.
Additionally, it is important to understand the rules and regulations governing retirement plans, as there may be penalties for early withdrawals or other violations.
How accounting software can track spend and categorize your business-expense deductions
Accounting software can help you keep track of your business expenses.
You can use it to categorize the costs and generate reports with information like the total expenses for each category, helping you stay organized.
Accounting software is beneficial because it allows you to:
- Track all your company’s expenses in one place.
- Automatically categorize purchases based on their type (such as travel or office supplies).
- Compare historical data over time.
Because all expenses are accounted for and properly categorized, you can make tax preparation easier and more efficient.
You can also more easily spot trends in your spending habits so that you can adjust as needed.
Here’s how to use accounting software for expense tracking and categorization:
- Choose your accounting software
Ideally, you want accounting software that’s cloud-based, easy to use, and works with receipt-snapping apps.
- Set up your accounts
Create accounts for all your business expenses, such as rent, utilities, office supplies, and travel expenses.
- Connect your bank accounts
Connecting bank accounts to your accounting software allows you to import transactions and reconcile your accounts easily.
- Categorize your expenses
Categorize each transaction by assigning it to the appropriate account. This will help you to track your expenses and create reports.
- Customize your categories
Customize your categories to fit your business needs. Create subcategories or rename categories to reflect your expenses better.
- Track receipts
Use your accounting software to track receipts and attach them to each transaction. This will help you stay organized and provide proof of expenses for tax purposes.
- Monitor your expenses
Monitor your expenses regularly to ensure you are staying within your budget. Use your accounting software to create reports and analyze your spending.
Common FAQs about business-expense categories
Can I deduct expenses for a home office?
Yes, if you use a portion of your home exclusively and regularly for business purposes, you could deduct home office expenses. These can include:
- A percentage of your rent or mortgage interest
- Repairs based on the square footage of the dedicated office space
What is the difference between direct and indirect expenses?
- Direct expenses are costs directly attributed to producing a specific product or service, such as raw materials or labor costs.
- Indirect expenses are costs that cannot be directly tied to a specific product or service but are necessary for the overall operation of your business, such as rent, utilities, and administrative salaries.
Can I deduct startup costs?
You can deduct certain startup costs, such as expenses incurred before the business begins operations.
You can usually deduct a portion of these costs in the first year and amortize the remaining over a specified number of years.
Can I deduct personal expenses partially used for business?
In some cases, you may be able to deduct a portion of personal expenses used for business purposes, such as a personal vehicle or cell phone.
To do this, you need to determine the business use percentage and apply that percentage to the total expense.
Are entertainment expenses deductible?
Entertainment expenses are generally not deductible, but business meals may be partially deductible, subject to specific rules and limitations.
Final thoughts on business-expense categories
Understanding business-expense categories is essential to maximize your finances.
Knowing which expenses are tax-deductible and how to track and categorize them properly can reduce your taxable income and save money on your taxes.
It’s also important to remember that expenses aren’t just costs to be minimized—they’re investments in your business’s success.
Ensure that every dollar you spend works by prioritizing expenses that will help you grow and improve.
Take the time to review your expenses, categorize them correctly, and use accounting software to keep track of everything.
With a little effort and attention to detail, you can turn your expenses into a valuable tool for building a successful business.