A Small Business Owner’s Guide to Business Expenses
What do printer ink, client lunches and shipping costs all have in common? They’re business expenses—the costs incurred while operating your business.
And as long as you run a for-profit company, you can deduct many of these expenses from your taxable income which can help your business’s finances at tax time.
What Are Some Examples of Small Business Expenses?
The types of business expenses vary depending on your specific business. For instance, a photographer who drives to events he’s been hired to shoot adds miles to his personal vehicle, which can be expensed. He may also have expenses related to equipment, editing software and his home office, a portion of his condo that he uses exclusively for his business. A retail shop owner, on the other hand, incurs other types of expenses, including her on-hand inventory, storage, and employee wages.
Common business expenses shared by nearly all companies, no matter the size or the industry, include advertising and marketing, office space, utilities, payments to employees and vendors, software (e.g. bookkeeping), and necessary equipment.
Your business expenses can translate into tax write-offs (or deductions) as long as they’re “ordinary and necessary“—that is, common in your industry and essential to your business. When an expense meets those requirements for your business, you can deduct it. Subtract the amount of the expense from your business’s gross income to reduce the overall amount on which you pay taxes.
Here’s a list of common deductions that business owners make in any given tax year:
· Internet, phone and software
· Office space and related utilities (including home offices)
· Office expenses (like paper and printer ink)
· Equipment (from computers to specialized tools and machinery)
· Payment to employees and independent contractors
· Employee training and education (including subscriptions and publications)
· Credit card processing fees
· Business travel and vehicle use
· Business meals*
· Advertising and marketing
· Interest payments
· Business insurance coverage
· Retirement plans and other benefits
· Taxes (real estate taxes, payroll/self-employment taxes, etc.)
*If provided by restaurants, businesses can deduct 100% of the cost for food and beverages—including employee meals—in 2021 and 2022.
Can a Business Expense Overlap With Company Expenses and Personal Expenses?
Yes, sometimes an expense can be broken down between your business and personal lives. For example, if you use part of your home as your office, then you may be able to make a home office deduction. In this case, you must use that area of your home solely for business purposes and, per the IRS, it must be the “principal place of your business.” So, if your main business location is a separate office space outside the home, then you may not qualify for this deduction, even if you occasionally work from your home office.
For those who are eligible for this deduction (see Figure A. for a flowchart guide), the standard method of deducting home office expenses involves calculating the percentage of your home that is used for business. Start with the square footage of your office area and divide it by the total square footage of your home. Let’s say your home office space is 100 square feet, and your home is 2,000 square feet. Divide 100 by 2,000 to arrive at 0.05, or 5%. Your office is 5% of your home, so you can deduct 5% of the cost of your mortgage interest, utilities, insurance and other related expenses at tax time.
You can apply a similar model to the times you use your personal vehicle for business, either keeping track of miles driven and deducting based on the IRS’s standard mileage rate or by figuring out the percentage of car use that goes toward your business. Let’s say you’re a realtor who uses your car to drive clients to showings. You keep detailed records of when you use your car for business, including dates, miles driven, and purpose of each car trip. At the end of the tax year, you’ve driven a total of 25,000 miles, which includes 15,000 business-related miles. You can either multiply your business miles (15,000) by the IRS standard mileage rate of $0.56, deducting $8,400, or you can calculate that you used your car for business 60% of the time (15,000 miles divided by 25,000 miles) and apply 60% of your vehicle operating expenses, including maintenance, fuel, repairs and insurance costs as a deduction. If you opt for the latter option, make sure you keep those receipts!
While home offices and personal vehicles are the most obvious examples of when personal and business expenses overlap, there are other occasions when expenses can blend between personal and business. For instance, if you use your cell phone for business 40% of the time, then 40% of your phone bill is deductible (if you’re using it as an employee, then it’s 100% deductible). Another IRS-provided example is borrowing money. If you take out a loan and use 85% for your business while the other 15% covers a family vacation, then you can deduct 85% of the interest as a business expense.
What Are Common Non-Deductible Business Expenses?
Some costs related to doing business cannot be deducted from your taxable income. Common examples include lobbying or political costs and penalties/fines. Additionally, any clothing that’s not part of a required uniform cannot be deducted, nor can entertainment costs such as tickets to a sporting event.
Finally, while they can still benefit you at tax time, the expenses incurred while figuring out your cost of goods sold (such as storage, rent, repackaging, etc.) as well as capital expenses (i.e. business assets and improvements) must be capitalized rather than deducted.
What Are Startup Expenses?
Startup costs include expenses that you incur while preparing and launching a new business, including organizational costs such as legal and state filing fees. Depending on the type of business—what it requires prior to and soon after your business starts—your startup expenses can vary widely.
What Are Some Examples of Startup Costs?
You pay startup costs as you prepare to open your business and soon after. They include any costs related to market research, product development, writing a business plan, borrowing money, obtaining necessary technology and filing registration paperwork with your state. Once your business starts, you’ll likely incur other types of startup costs, including advertising, business travel, special promotions and employee wages.
How Do You Calculate Startup Costs?
When considering how much money you’ll need to start your business, break down your startup expenses into two categories: one-time and recurring. Consider which of the following types of business expenses you may need to pay upfront and in the near future as you calculate your business startup costs:
· Materials and equipment
· Business licenses and permits
· Market and product research
· Employee expenses (e.g. wages, benefits, payroll taxes)
· Marketing and advertising
· Professional services (e.g. lawyers, business consultants, IT specialists, website designers)
Once you’ve identified and categorized your startup costs, create a visual one-page report that you can add to your business plan, which will help guide you as you seek various types of funding. Here’s an example of a startup cost report from the Small Business Administration.
Can Startup Costs Be Deducted?
While some startup costs, like a company truck, need to be treated as capital expenditures and depreciated or amortized over time, there are some types of startup costs that you can deduct. Generally, deductible startup costs fall into three categories:
· Creating your business
· Preparing your business for opening
· Legally organizing your business
If your total startup expenses are $50,000 or less, then the IRS allows you to deduct up to $5,000 in business startup costs and $5,000 in organizational costs.
Tips for Keeping Track of Your Small Business Expenses
The first thing you need to do is separate your personal funds from your business funds. So, open separate business checking and savings accounts for your business. After that, make sure to also keep your business expenses separate from your personal expenses. Consider applying for a business credit card to simplify your efforts to maintain clear differentiation.
When it comes to tracking income and business expenses, some small business owners do so manually. If you prefer this method, scan and save your receipts in carefully organized digital folders. Also maintain spreadsheets for your records, entering your income and expenses data under the following columns: Date, Category, Vendor, Cost, Purpose. Some business owners find that their finances are too complex for this method.
Depending on the amount and the variety of your expenses, you may decide to use accounting software. If you’re often on the go, consider a cloud-based accounting tool, like Freshbooks or QuickBooks. Both include a mobile app, making it easier to enter and track business expenses no matter where you are and when they happen. This could save you a huge pile of paperwork down the road while also lowering your risk of losing out on tax deductions due to forgotten or lost receipts.