Writing off business expenses to reduce taxable income is a vital tool all enterprises utilize to lower their total tax burden. Unfortunately, as not every company expense qualifies as a deduction, it’s also an area of tax accounting where many mistakes are made.
In this post, we’ll provide a basic framework to help you better understand which business expenses can be written off and which cannot. Knowing exactly what the IRS considers a business expense can help you make smarter spending decisions and avoid unnecessary complications when it comes time to file your return.
Ordinary and necessary
According to the IRS, business expenses can be deducted when they are both ordinary and necessary.
The IRS defines these two qualifiers as such:
- Ordinary – one that is common and accepted in your trade or business
- Necessary – one that is helpful and appropriate for your trade or business
If the expense aids in the operation of your business and most businesses like yours choose to use it, then it most likely qualifies as a tax-deductible business expense.
Note: Not all eligible expenses are 100% deductible. Some expense categories only qualify for a partial deduction.
Tax-deductible business expense categories
While this list is not exhaustive, these are the expense types most commonly used as write-offs:
- Location costs – rent, lease or mortgage payments
- Utilities – water, electricity, natural gas, waste management
- Communications services – telephony and internet
- Insurance – property, liability, business interruption, workers’ comp, health/vision/dental for employees
- Office and specialized equipment – computers, printers, desks, chairs, office supplies and industry-specific tools/materials/supplies
- Payroll – employee wages and benefits
- Marketing – includes advertising, online campaigns and internal expenses such as web development, logo design, flyers and business cards
- Taxes – includes all taxes to local, county, state or federal governments
- Licensing and permits – business fees and trade association fees may be deductible
- Business meals – both internal meetings and meetings with clients or prospects
- Gifts for employees – gifts for promos and events are deductible up to a set amount
- Business travel – includes company cars or rentals, gas, insurance, plane/train/bus fare, lodging and meals
- Continued education – classes, workshops, seminars and purchased books or industry publications
- Legal and professional fees – accountants, lawyers and other necessary professional guidance
- Loans and related interest payments – can be credit card balances or direct loans with banks or vendors
- Depreciation – for any qualified capitalized asset
- Property maintenance – cleaning or servicing of business grounds
Three major types of business expenses
- Fixed expenses, also called overhead, stay roughly the same over reporting periods. Examples include lease payments, insurance and wages.
- Variable expenses fluctuation throughout the reporting period. Examples include purchasing inventory, utility bills and costs that vary with sales volume.
- Periodic expenses do not occur in every reporting period. Examples include emergency building repairs, annual bonuses and unplanned equipment maintenance.
What about capitalization?
Larger expenses made as investments in the generation of future revenue are capitalized, or depreciated over time, in lieu of being taken as a single write-off. Some expenses such as buildings, vehicles and expensive machinery MUST be capitalized. Other expenses, for example a $500 printer, can either be capitalized or expensed.
Deciding when you should write-off or capitalize expenses that fall into the gray area will depend on other financial factors and your accounting goals for that fiscal year.
Tips for tracking business expenses
Small business owners who are new to tracking business expenses should start by opening a separate business bank account. Be sure to run all business-related expenses and income through this dedicated account.
You should also consider:
- Purchasing business accounting software, such as QuickBooks, to automatically record business expenses through a connection to your business bank account.
- Keeping all receipts and invoices related to business spending to maintain a clear paper trail in the event of an IRS audit.
- Conducting regular reviews of your business expenses to identify cost reduction opportunities and make more informed decisions regarding future spending.
Personal expenses are not business expenses
Personal expenses can never be used as tax deductions unless the expense is also used directly in business operations. There are, however, exceptions where small business owners can write off the portion of an expense used for business purposes.
Common shared expenses that may qualify for a partial write-off include vehicles, computers, phones and other tools/equipment. Business owners who work from home can also deduct a certain amount to account for the cost of their home office.
Note: Be sure to carefully track and document how you calculated the percentage of any expense as being business related. For example, keeping a log of business trips in a vehicle you use both for work and your personal transportation.
Maximize tax efficiency
Missing eligible business expenses is a tax inefficiency that costs your business money every time you fail to record a deduction.
Looking at a simple example, say you spend $50 filling up your company car with gas to be used for business purposes. If this expense is recorded, the cost of the gas remains at $50. But if you fail to deduct the expense, the real cost to your business is closer to $57.50 (depending on your tax bracket), as the $50 you would have deducted is now taxes as income.
This is why implementing a tracking system that doesn’t let business expenses fall through the cracks is so important.
Schedule a business expense advisory session
Proper management of business expenses is an important aspect of any successful tax accounting strategy. Accountability Services offers a specific advisory session to address this topic so you, as a business owner, can create the greatest impact on your taxable income while making the right purchases to drive your business forward.
To book an advisory session, please email MasterPlan@AccountabilityServices.com or call our Seattle CPAs at 206.522.0110.