What’s a business expense (for tax purposes)?
Hello fellow business owners! As an accounting professional and someone who loves helping businesses thrive, one of the most common questions I get is: "What exactly counts as a business expense for tax purposes?" It's a fantastic question because understanding this can significantly reduce your taxable income and save you a lot of money.
The good news is, the IRS wants you to deduct legitimate business expenses. Why? Because it reflects the true cost of earning your income, leading to a fair tax calculation. The key, as the IRS puts it, is that an expense must be both "ordinary and necessary."
Let's break down what those terms mean and dive into some common examples and pitfalls.
What Does "Ordinary and Necessary" Mean?
Ordinary: This means the expense is common and accepted in your industry. It doesn't have to happen regularly, but it should be an expense that businesses like yours typically incur. For example, a restaurant buying food ingredients is ordinary. A web designer buying coding software is ordinary.
Necessary: This means the expense is helpful and appropriate for your trade or business. It doesn't have to be essential for your business to exist, but it should contribute to its operation or income generation. For example, marketing expenses are necessary because they help attract customers.
Crucially, business expenses cannot be personal expenses. This is where a lot of confusion (and potential trouble) arises.
Common Examples of Qualified Business Expenses
Here's a friendly rundown of expenses that generally qualify, provided they meet the "ordinary and necessary" criteria for your specific business:
Office & Administrative Expenses:
Rent: For your office space, storefront, or warehouse.
Utilities: Electricity, water, internet, phone, gas for your business location.
Office Supplies: Pens, paper, printer ink, cleaning supplies for your workspace.
Software & Subscriptions: Accounting software (like QuickBooks Online!), industry-specific tools, professional journal subscriptions.
Postage & Shipping: Costs to send products or business-related mail.
Employee & Labor Costs:
Salaries & Wages: Payments to employees, including bonuses and commissions.
Employee Benefits: Health insurance premiums, retirement plan contributions, workers' compensation.
Contractor Payments: Fees paid to freelancers or independent contractors.
Marketing & Advertising:
Online ads (Google, social media)
Print ads, brochures, flyers
Website development and hosting fees
Promotional materials
Travel & Vehicle Expenses:
Business Travel: Airfare, lodging, and transportation (taxis, ride-shares, rental cars) when traveling away from your tax home overnight for business.
Business Meals: Generally 50% deductible if they are directly related to business activities and not lavish or extravagant.
Vehicle Expenses: If you use your car for business, you can deduct either the actual expenses (gas, oil, repairs, insurance, depreciation) or use the IRS standard mileage rate. You must keep good records of business vs. personal miles.
Professional Services:
Accounting & Bookkeeping Fees: Payments to CPAs, bookkeepers, tax preparers.
Legal Fees: For contracts, business formation, intellectual property protection, etc.
Consulting Fees: Payments to business consultants or advisors.
Insurance Premiums:
General liability, professional liability (malpractice), property insurance for your business assets, business interruption insurance.
Education & Training:
Courses, workshops, seminars, or certifications that maintain or improve skills needed in your current business.
Interest Expenses:
Interest paid on business loans, business credit cards, or a business mortgage.
Depreciation:
For large assets like equipment, vehicles, or buildings, you deduct a portion of their cost over their useful life rather than all at once.
Common Pitfalls That Lead to Misidentifying Business Expenses
Even with good intentions, it's easy to make mistakes. Here are some common traps to avoid:
Mixing Personal and Business Finances: This is the #1 culprit! Using your personal bank account or credit card for business expenses (or vice versa) creates a muddy mess.
The Fix: Always, always, always keep separate bank accounts and credit cards for your business. It makes tracking expenses infinitely easier and lessens the chance of an IRS red flag.
Lack of Documentation: The IRS loves receipts! If you claim an expense, you need to prove it.
The Fix: Keep meticulous records. For every expense, you should have:
Amount: How much it cost.
Date: When it was incurred.
Vendor: Who you paid.
Business Purpose: Why it was a business expense. (Especially critical for meals, travel, and gifts).
Tools like QuickBooks Online allow you to snap pictures of receipts with your phone and attach them directly to transactions, making record-keeping a breeze.
"Personal" Expenses Disguised as Business: This includes things like:
Commuting: Your daily commute from home to your primary workplace is generally not deductible.
Personal Meals/Groceries: Unless it's a qualified business meal, your daily coffee or groceries for your personal kitchen are not deductible.
Clothing: Most clothing isn't deductible unless it's a uniform or protective gear not suitable for everyday wear (e.g., scrubs, hard hat). A fancy suit for meetings is personal.
Personal Hobbies: Turning a hobby into a business can be tricky if it doesn't genuinely aim to make a profit.
Overstating Deductions: Inflating the cost of an expense or claiming things you didn't actually incur. This is a direct route to an audit and penalties.
The Fix: Be honest and accurate. When in doubt, err on the side of caution or consult with a tax professional.
Misunderstanding "Meals & Entertainment" Rules: Before 2018, entertainment was often deductible. Now, it's generally not. Business meals are still 50% deductible if they meet specific criteria (business discussion, not lavish, taxpayer or employee present).
The Fix: Stay updated on tax law changes and properly categorize these expenses.
Incorrectly Classifying Assets vs. Expenses: Sometimes, a large purchase (like a computer or machinery) isn't fully deductible in the year you buy it. It's a capital asset that must be depreciated over several years.
The Fix: Consult with your accountant or accounting software to ensure large purchases are correctly categorized and depreciated.
The Power of Good Record-Keeping
The golden rule for business expenses is: If you can't prove it, you can't deduct it. This is why strong record-keeping is non-negotiable. Using accounting software like QuickBooks Online is invaluable here. It allows you to:
Categorize expenses easily: Assign expenses to the correct accounts.
Track mileage: Many QBO versions offer mileage tracking.
Connect bank and credit card accounts: Automatically import transactions for faster categorization.
Attach receipts: Snap photos of receipts directly to transactions.
Generate reports: Easily pull reports of all your expenses for tax preparation.
By understanding what qualifies as a business expense and diligently tracking your spending, you can confidently take advantage of legitimate deductions, keep more of your hard-earned money, and ensure a smoother tax season. When in doubt, always consult with a qualified tax professional!