What Are Business Expenses? How to Fuel Smart Tax Savings

You can’t run a business without knowing what makes you money and what drains it. 

Every business has expenses, whether you operate from home or a corporate office. Tracking these expenses is incredibly important for a business owner, big or small. These expenses can be capital or operational expenditures, which appear as deductions on the income statement. 

You can calculate your company’s taxable net income by subtracting these deductions from the total revenue. Companies generally track and manage business expenses using accounting software.

What are business expenses?

Business expenses, also known as business deductions, are costs incurred due to normal business operations, regardless of the size of the company. In order to calculate net income, businesses must subtract their expenses from their revenue.

The Internal Revenue Service (IRS) Publication 535 gives you a clear idea of deductible and non-deductible business expenses. It states that a business expense must be both necessary and ordinary to be tax deductible. These expenses can be fully or partially deductible. 

Ordinary expenses are common business-related expenditures like telephone line installation fees. Necessary expenses are the ones that help you trade efficiently. Expenses don’t have to be indispensable to be considered necessary. Common examples include rent, payroll, and inventory.

It’s important to be able to differentiate between business and personal expenses. Is a lunch with your coworker really helpful for your business? How about that lava lamp on your desk? Unfortunately, neither of those things falls under deductible business expenses.

Business expenses vs. personal expenses

Business expenses are what you spend for business purposes or while running business operations. Common business expenses occur when you buy equipment to streamline manufacturing or rent office space. You can deduct these expenses from your income to lower tax liabilities. Make sure documents for these expenses clearly mention the expense amount, merchant name, and date. 

Personal expenses are those that aren’t necessary for business operations. That’s why it’s wise to use business bank accounts for business-related expenses. That way, you can keep personal expenses separate for tax purposes. 

Types of business expenses

• Utilities
• Software
• Furniture
• Subscriptions
• Office supplies
• Business meals
• Office space rent
• Business vehicles
• Commission and fees
• Bank fees and interest
• Business travel expenses
• Employee retirement plans
• Employee education plans
• Employee benefit programs
• Business insurance expenses
• Equipment or equipment rentals
• Payroll for employees and freelancers
• Membership fees for union or professional affiliations

Income statement reporting

An income statement is the main financial statement that businesses use to record expenses and determine taxable income. Income statements give you a 360° view of expenses, direct costs, indirect costs, and revenue. 

Direct costs

Direct costs are expenses that you directly incur while producing goods or services. This cost of goods sold (COGS), also known as the cost of manufactured or purchased goods sold, is a large contributor to the direct expenses of a company. 

Direct cost examples

• Storage
• Factory overhead
• Direct labor costs
• Raw material expenses
• Shipping or freight charges
• Distribution or sales force costs

COGS equals the difference between on-hand inventory at the beginning and the end of a tax year. This difference is also known as the value of inventory. You can deduct the COGS or inventory value from the total revenue to find the gross profit for the year. 

Indirect costs

Indirect costs are operating expenses that your business incurs for administration and day-to-day maintenance activities. Common examples include general expenses, executive salaries, marketing costs, and depreciation.

These operating costs can be fixed, variable, or semi-variable as they don’t fluctuate with manufacturing or sales. Deducting indirect costs from the gross profit gives you the earnings before interest and taxes (EBIT). 

Depreciation 

Depreciation is the process of allocating or deducting the cost of a physical business asset over a long period of time instead of one year. Depreciation expenses apply to assets like properties, furniture, computers, etc. 

You can show depreciation as a tax-deductible, indirect expense on the income statement. According to the Generally Accepted Accounting Principles (GAAP), companies must use standard depreciation methods and specific depreciation schedules.

Amortization is similar to depreciation but applies to the cost of an intangible asset. Businesses can also show interest expenses or interest paid on loans from their taxable income.

Deductible business expenses for taxes

Going back to the definition from the IRS, business expenses are deductible if they are deemed ordinary (other businesses like yours have this expense, too) and necessary (the expense is helpful to your business).

Examples of fully deductible business expenses 

• Interest paid
• Insurance cost
• Equipment rentals
• Contract employee wages
• Credit card processing fees
• Employee benefit programs
• Office expenses and supplies
• Office lease and utility expenses
• Advertising and marketing expenditure
• Certain licensing, regulatory, and legal fees
• Educational expenses for training employees

Location

Most businesses need a physical location to operate from – brick-and-mortar, office space, and so on. With those spaces come mortgages, leases, rents, and utilities, all of which are deductible business expenses. And this includes phone and computer expenses too.

If you’re a self-employed small business owner operating from your home, you may be eligible for a partial deduction on property taxes, mortgage interest, and home office space which is the main place of business. 

The IRS publication 587 has some very strict rules about home office deductions. 

Not sure what’s deductible? Consider using small business tax software for streamlining tax filing.

Equipment

Assets that you buy for business use (for example, printers, office furniture, shelving, etc.) fall under deductible business expenses.

The cost of these assets is a little tricky because they depreciate over time. Think of the value of a car when it leaves the lot; the cost of long-term assets does something similar where the value of the asset reduces over a period of time. Enterprise asset management (EAM) software can help larger businesses keep a tab on how much their assets are worth. Consider calculating the depreciation before deducting the appropriate amount.

Office supplies

Things like staples, printer paper, sticky notes, highlighters, and other office supplies may seem minuscule. But when you’re replenishing them every month, they can really add up. Keeping an inventory of these little things can be extremely helpful when submitting them as deductible business expenses.

Software

The help that some software can provide a business with is unparalleled to anything else, making it essential for freelancers and businesses both big and small. All of that software is going to be important to keep track of so that you can deduct the essentials from your taxes.

Keeping an eye on the contracts your business has with vendors, down to the individual seats for your employees, can help you manage the amount of money you’re spending in the first place. With G2 Track, you can do all of that and more.

There are some special circumstances in which software is non-deductible. To be safe, check Section 179.

Advertising and marketing

Print and digital advertising costs, as well as the costs of any marketing materials and promotional materials, can be deducted. Costs for the printing or digitizing of these might be plenty, but consider how much you’re paying your freelance graphic designer to come up with a new concept, as well as how much you’re paying for delivery. Those costs can be deducted, too.

Partially deductible business expenses

The list above makes it pretty clear that deductible business expenses are just that: business expenses. There are, however, times when the line between business and personal expenses becomes a little blurred.

For example, gifts, entertainment expenses, and some travel expenses are only partially deductible, according to the IRS. You may want to delve into the details of the IRS Publication 535 with a professional accountant to make sure you’re recording everything as accurately as possible.

Nondeductible business expenses

Finally, there are some business expenses that the IRS just won’t deduct. First and foremost, the IRS will not deduct anything that you do not provide proof of. If you don’t have the records, don’t bother submitting them. But even with the records, the following will never be deductible:

• Club dues
• Clothing for work
• Political donations
• Fines and penalties
• Commuting costs
• Federal or state income taxes and other taxes

Tips for managing business expenses

Business expenses can be challenging to manage, but they can also help you minimize overall tax liabilities. Try these tips for streamlining business expense management. 

• Maintain meticulous records for tax deductions and IRS audits. The IRS requires you to keep receipts, employment records, and tax returns for up to four years. If you’re writing off bad debt, consider keeping the relevant documents for seven years.
• Keep receipts for tax-deductible business travel expenses, including transportation, lodging, and business meals.
• Separate personal and business expenses because you can write off business expenses to reduce tax liability.
• Keep yourself up-to-date on tax-deductible expenses. While not all expenses are tax deductible, the majority of them can be eligible for tax write-offs. For example, you may not be able to write off the capital expenditure of a large piece of equipment in a year. But you can write off its operational costs and depreciation value.
• Review expenses periodically. Implement robust expense management policies and double-entry bookkeeping to track expenses and prevent accounting errors.

Accounting software for business expenses 

Accounting software solutions ensure accurate record-keeping by automating finance management processes. Depending on the software you choose, you’ll also be able to handle invoicing, financial reporting, payroll processing, and reconciliation. 

Stay accountable with better accounting

In reality, the definition of business deductions makes perfect sense. The hard part is keeping track of business income and expenses, and knowing what is deductible and what’s not.

If you have the time to read up on it yourself, feel free. But know that there are also tax professionals or certified public accountants (CPAs) who are out there that would be more than happy to help you with business accounting. 

Check out the best accounting platforms that help you work smarter and grow faster.

This article was originally published in 2019. It has been updated with new information.