Attention to expense deductions may not play a prominent role in the financial planningprocess for small businesses and startups—and that may be costing them. Sure,you’refocused on customer service and improving your products and services. But some easy movescould significantly lessen your tax bill.
For example, say you’re putting 250 miles per week on your private vehicle to getproductsout to customers. It may seem time-consuming to keep a log separating business and personaluse, but you’re losing out on close to $600 in deductions. Or maybe you shuttered youroffice and started running your company from a spare room. As long as the space isexclusively used for business, you can deduct $5 for every square foot, up to $1,500.
Business expenses are the costs of running a company and generating sales. Given that broadmandate, the IRS doesn’t provide a master list of allowable small-business and startupdeductions. As long as an expense is “ordinary and necessary” to running abusiness in yourindustry, it’s deductible. That makes it well worth the time to organize your spendingsoyour business takes all legitimate write-offs, creates an effective financialplan, pays the proper amount in quarterly taxes—and doesn’t need to sweat an audit.
What Is a Tax-Deductible Business Expense?
Which expenses may be written off varies depending on the nature of your business. Start byreviewing Internal Revenue Service Publication 535, whichdiscusses the deductibility of common business expenses and general rules for filing yourtaxes.
Those “ordinary and necessary” expenses must be incurred in an organizationmotivated byprofit. Even if your small business facesfinancial problems and doesn’t actually generate a profit, the intent needs tobethere. Otherwise, the IRS may determine your business is a hobby and disallow expenses.
The IRS also suggests distinguishing usual business expenses from categories that fall underthe cost of goods sold (COGs) and capital expenses toensure accuracy, since some business expenses cannot be deducted in the year they’reincurred.
What Are Business Expense Categories?
By developing expense categories that fit your business and recording and organizingexpenditures as you go, you’ll find it easier to get all the deductions you’redue.
You’ll also save significant headaches for your bookkeeper or taxpreparer. Speaking of, it’s worth spending time with a financial adviser tounderstand the types of expenses you can and can’t include in a specific category.
Below is an example small-business expense categories list that applies to most companies,outlining what’s included and how you can qualify for a deduction. Add to thisindustry-specific categories, such as R&D costs or spending to seek VC funding.
36 Business Expense Categories for Small Businesses and Startups
Advertising:
This covers the cost of items and services to directly promote or market yourbusiness. Examples include fees paid to advertising or marketing companiesto produce promotional materials, billboards, brochures, posters, websites andsocial media images. You may even deduct spending on a PR campaign.
Continuing education:
This can include courses for continuing education or seminars to stay current onindustry trends. Relevant materials, books and registration fees for you and youremployees are tax-deductible. You can also deduct payments made to employees toreimburse them for relevant educational expenses.
Credit and collection fees:
Businesses that use accrual basisaccounting, where revenue and expenses are recorded when they’reearned orincurred even if no money changes hands at that point, can deduct unpaid invoices asbusiness bad debt. Any fees spent trying to collect on debt, such as hiring anoutside company to collect what’s owed, also count. A better bet: Minimize baddebtand increase cash flow by optimizing your billingprocesses.
Bank fees:
Interest paid on business loans, ongoing credit lines and businesscredit cards are tax-deductible expenses. Bank fees, such as monthlymaintenance or overdraft fees, also count.
Dues and subscriptions:
Subscriptions to industry magazines or journals related to your business can bededucted on your taxes. Membership fees include those paid to professional or tradeassociations that can help promote your business and even to your local Chamber of Commerce.
Employee benefit programs:
Payments made toward benefits such as disability insurance, life insurance, dependentcare assistance, health plans for you and your employees and adoption assistance aretax-deductible. Note that this is one area, along with workers’ compensationinsurance, where companies tend to spendmore than they need to.
Insurance:
Besides that workers’ compensation insurance, you can deduct premiums forbusiness-related insurance, including for liability, malpractice and real estate.Auto insurance premiums on a personal vehicle are a bit more complicated: If youdeduct a flat mileage rate, you can’t itemize andmustuse the actual expense method, where you determine what it actually costs to operatethe car for the portion of the overall use of the car that’s business use.
Maintenance and repairs:
Companies that use fleet vehicles as part of their operations can deduct the portionused for business. Deductible expenses include parking fees and gas. Otherwise, youcan choose to utilize the standard mileage rate. Additionally, repair andmaintenance of other types of equipment and machinery used in your business can alsocount.
Under actual expenses calculations for vehicles, you may include gas, oil, repairs,tires, insurance, registration fees, licenses and depreciation (or lease payments)prorated to the total business miles driven.
Legal and professional expenses:
These can include fees paid to certified public accountants (CPAs), financialplanners, lawyers or other types of professionals.
Office expenses and supplies:
Items such as cleaning products, paper, notebooks, stationery and even snacks andbeverages for employees can be deducted as supplies. Theexpenses category includes costs related to operating yourbusiness, such as website hosting and software.
Telephone:
Monthly telecommunications fees in a commercial space can be deducted, as canadditional phone lines in a home office as well as cell phone contracts as asubcategory of office expenses.
Utilities:
For a commercial space, utilities such as electricity, internet, sewage and trashpickup fees are fully deductible. For a home office, you can deduct utilities inproportion to how much of your home is used for business.
Postage and shipping:
Stamps, freight and postage fees to mail business-related items, including productsto customers and return shipping labels, count. Envelopes and packaging materialsare included in office supplies.
Printing:
Items such as ink cartridges, printers or payments for printing services can beincluded under this business expense category. Note that if you decide to do some direct-mailmarketing, you can deduct the cost of producing the materials here, butpostage must be listed separately even if the printer handled mailings.
Rent:
Any rental payments made to occupy a warehouse for inventory or office space toconduct business are tax deductible. Your businessstructure—C corporation (C-corp) or S corporation(S-corp)—dictates whetheryou can pay a reasonable amount to rent property from shareholders.
Salaries and other compensation:
Employee salaries, gross wages, commissions, bonuses and other types of compensationcount as tax-deductible expenses. Compensation can even extend to salaries paid tochildren and spouses, provided payments were made through payroll and thoseindividuals performed services for your business. The amount paid does need to beconsidered reasonable.
Travel:
Business-related travel expenses include flights, hotels and meals—but notethat only50% of the cost of meals for employees and customers is deductible. Costs forcandidates who are traveling for an interview are deductible. Examples includeparking fees and flights.
Utilities:
Costs include cell phone, electricity, internet, sewage and trash pickup fees (forcommercial spaces).
Business meals:
You can deduct 50% of qualifying food and drink purchases. It needs to be related tothe business, such as work conferences and meals on business trips. As a smallbusiness, you can deduct 50% of food and drink purchases that qualify.
Business use of your car:
You may be able to write off costs of maintaining and operating your vehicle ifit’sstrictly for business use. However, if it’s mixed, you can claim mileagerelated tothe business use.
Moving expenses:
For work-related moving expenses, you may be able to deduct 100% of the costs relatedto your move. You will need to pass the distance test, such as your new job locationbeing at least 50 miles from your former location.
Depreciation:
These are costs for big ticket items like machinery or a vehicle over its lifetimeuse, instead of it over one single tax year.
Charitable contributions:
You can deduct charitable contributions made to qualifying organizations—youmay needto itemize these deductions.
Child and/or dependent care:
Qualifying costs associated with child or dependent care can be written off, thoughyou’ll need to meet the IRS requirements.
Startup expenses:
Businesses who launched a new venture may be able to deduct up to $5,000 in startupexpenses leading up your launch. Examples include marketing and employee trainingcosts.
Mortgage interest:
If you’re purchasing a building or taking out a loan to build or improve yourhomefor business purposes, you may be able to deduct the interest incurred.
Software:
Ones, such as bookkeeping software or recurring subscription with SaaS companies,used for business related purposes may be fully tax deductible.
Books and magazine subscriptions:
Magazine, books and journals that are specialized and directly to your business maybe tax-deductible. For instance, newspapers may not be, but industry-specificmagazines would.
Foreign earned income:
If you have a business based abroad you may be able to leave out any foreign incomeearned off your tax return, known as foreign earned income exclusion. You’llneed tomeet certain requirements such as being under a certain income threshold.
Medical expenses:
Self-employed individuals, who pay for their own medical care expenses or insurancepremiums, can deduct these expenses on their tax return. Examples includedoctor’sfees and prescription drugs.
Licenses and permits:
Any required licenses and permits can be tax deductible. Examples include buildingpermits and licenses to practice law in your state.
Manufacturing or raw materials:
These are directly related to the cost of goods sold or items and storage paid tosell your products.
Retirement contributions:
Contributing to a tax-advantaged account, such as an IRA or 401k, can reduce yourtaxable income—a great way for those who are self-employed to save on taxes.
Real estate taxes:
If you have a home office and itemize your taxes, you may be able to deduct some ofthe taxes you pay.
Client gifts:
Gifts for employees, clients or vendors may be fully tax deductible. For example, yougive your employees gift baskets during the holiday season or send gift cards tovendors.
Employee loans:
If you pay an advance to an employee and expect them to pay you back (as in, theydidn’t do any extra work to earn this “extra” income), you candeduct this amount.However, any interest paid may count as business income.
Skip the Golf?
| Expense | Deductible Amount |
|---|---|
| Party or cookout for employees | 100% |
| Reimbursable meals for employees | 50% |
| Meals with customers or prospects | 50% |
| Other entertainment for customers or prospects, such as a sportingevent or round of golf | 0% |
If you have employees who frequently travel for business, ensure you follow small-business expensemanagement best practices like making it easy for them to upload the receiptsrequired by the IRS.
3 Steps to Categorize Expenses for Your Small Business or Startup
Poor tax compliance and inconsistent cash flow are among the top 10 financialchallenges for small businesses. You can break that mold by being consistent incategorizing expenses. That allows you to see where and how much you’re spending tooperateyour company while being prepared come tax time.
You’ll also gather insights that will enable you to create a financialstatement that adds visibility into profitability and cash flow. These statementsare required for audits and are often requested by investors.
Here are three steps to categorize business expenses.
Determine correct categories for your specific business.
Choosing the right categories will depend on your industry. For example, a greetingcard business may have dedicated categories for shipping and storage rental, whereassoftware-as-a-service (SaaS) companies may havecategories for digital services.
Start by identifying the expense categories your business uses the most—thatfinancial statement will help here—and ones that you’ll need to grow.Refer to thelist above to get started.
Reconcile and review financial accounts regularly.
Reviewing financial accounts is a good habit that will encourage you to stay on topof your expenditures. Reconciling bank statements can be easily done usingaccounting software. If you find you’re having challenges, a business-onlycreditcard is a top expensemanagement best practice.
Assign a category to all transactions.
Using the list of categories you came up with, look at your spending details andassign anything deductible. Pay particular attention to where receipts are required.Note that keeping business and personal finances separate is a top financial tip forsmall businesses and shields you from liability, so as you assign anexpense, make sure it’s business-related.
What Else Can I Deduct as a Business Expense?
As we’ve mentioned, your home can yield many deduction opportunities, based on thepercentageof space your office occupies—but you’ll need to itemize mortgage interest,utilities,insurance and property taxes. Or, you can claim the standardized deduction, which is $5 persquare foot up to 200 square feet.
A few other items you may not have considered:
The Work Opportunity Tax Credit (WOTC) isa Federal tax credit available to employers for hiring individuals from certain groups,including some veterans and disabled individuals, who face significant barriers toemployment.
Costs to protect intellectual property created by you or your employees,such as software code, a logo for your business or a patent for a new product or service.
Losses from a natural disaster or crime. If a fire or flood destroys yourstock, or items are stolen, you may deduct losses not covered by your insurance.
Use Accounting Software to Track Spending and Categorize Business Expenses
One of the easiest ways for business owners to categorize expenses and track spending is touse accounting software,which often has prepopulated business categories. You can amend or add as needed, and itwill automatically compile transactions.
Accounting software also helps you to use the data from your expenses to run profit and lossreports. Doing so shows you the amount you’re spending in each category so you canassesswhether you need to get your costs under control or if you’re on track. You can breakdownspending at specific time intervals to see how expenses change. These reports simplify thededuction process while revealing your annual business expenses.
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One of the most exhaustive guides to what requirements need to be met for qualifying businessexpenses is the IRS publication 535. However, if you want a resource that’s easier towadethrough, download our free overview guide. You can review a list of commonbusiness expense categories as well as nondeductible items.
Small Business and Startup Expense FAQs
What can be written off as a business expense?
Generally, if an expense counts as ordinary and necessary to conduct business, you can deductit as a business expense. There is no comprehensive list because what counts as“ordinaryand necessary” is highly dependent on industry.
What can’t be written off as a business expense?
Any spending considered a personal expense can’t be written off. In addition, youcan’tdeduct expenses related to client entertainment, with the exception of meals; fines orpenalties for violating a law; country club dues; and illegal payments.
Can you deduct job expenses?
As of 2018, job expenses, such as for a relocation or other costs paid by workers but notreimbursed by employers, are no longer eligible. However, if a business reimburses anemployee, then the employer can deduct that reimbursem*nt as an expense.
Can I write off my business startup costs?
Businesses can write off startup costs, depending on the type of expenditure. Allowabledeductions must be directly related to getting the business up and running andorganizational in nature, such as training staff and incorporation fees. You may be able todeduct up to $5,000 for startup and an additional $5,000 for organizational costs.
Can I take the standard deduction and still deduct business expenses?
Yes, you can deduct business-related expenses even if you take the standard deduction.
What are three major types of expenses?
The three major types are fixed, variable and periodic.
- Fixed expenses are those that don’t change for the foreseeablefuture.These can include auto lease payments or rent.
- Variable expenses are expenses such as utilities, which can change frommonth to month.
- Periodic expenses are ones that happen occasionally, like businesstravel or emergency car repairs.
