Throughout most of the year, a business tries to minimize its expenses. At tax time, however, expenses can be a benefit: They help reduce a company’s tax bill.
U.S. tax law recognizes that businesses have to spend money to make money — such expenses are generally referred to as outlay costs. Therefore, it allows companies to subtract many expenses from revenues to reduce their taxable income.
However, a business must understand which expenses are deductible and how to deduct them. Not everything on which a company spends money qualifies as a tax-deductible business expense.
To take full advantage of deductions, a tax accountant needs to understand the types of business expenses that can be tax-deductible, as well as their limitations, to figure out what qualifies and what doesn’t.
25 Types of Business Expenses
To be considered a reasonable business expense under Section 162 of the Internal Revenue Code, an expenditure must satisfy one of two conditions:
- It must be ordinary, meaning that it’s typical for most businesses in the same industry.
- It must be necessary, meaning that it’s needed to operate the business.
For example, paying an owner’s personal bills isn’t necessary to operate a business, so it’s usually not deductible.
Fortunately, a wide variety of expenses do meet those tests. The following are 25 types of business expenses that can generally be written off on tax returns, along with key limitations on claiming those expenses.
Bank Fees
If a business has its own bank and credit card accounts, it can deduct service fees, transfer fees, processing fees, and overdraft fees.
Business Licenses and Permits
Many kinds of businesses need licenses to start operating, from cosmetology to construction, and some licenses must be periodically renewed. The IRS considers these necessary costs.
Business Taxes
Businesses can deduct taxes that they pay to state or local governments such as real estate taxes, sales taxes, fuel taxes, and state income taxes. Federal payroll taxes for employees are also deductible.
Business Travel and Business Meals
If an employee takes a business trip lasting at least one night, a company can claim expenses such as transportation, lodging, and meals, with two important limitations:
- If part of a trip is personal, only the business part is deductible.
- For meals, only 50% of expenses can be deducted. (Due to COVID-19, the IRS has granted a temporary exception to this rule, allowing businesses a 100% deduction for food or beverages from restaurants. This exception is slated to expire at the end of 2022.)
Charitable Contributions
If a company gives to a qualified charity, such as a 501(c)(3) nonprofit, it can deduct its entire contribution. Before donating, however, it’s important to confirm that the organization is eligible.
Deductions for charitable contributions are also limited based on the company’s income. If the company isn’t profitable, the contribution isn’t deductible in the current year but may be carried forward to a future year.
Commissions
If a company uses salespeople, it can deduct the commission and fees it pays to them.
Company Vehicles
If a business provides vehicles for its employees, it can depreciate part of the purchase price each year, while fully deducting current-year expenses such as gas, repairs or leases.
Different rules apply if the owner uses a personal vehicle. The business can claim expenses for the number of business miles driven, but not for personal miles driven. For 2021, the deduction was 56 cents per mile. The 2022 deduction is likely to be higher due to inflation and, in particular, gas prices.
Depreciation Costs
For assets expected to last more than one year — such as machines, vehicles, and computers — a business often can’t deduct the entire purchase price at once.
Instead, it depreciates a percentage of the asset’s value each year until it’s written off the entire cost. The length of time for depreciation varies widely, depending on the type of asset and the accounting method required by the tax law.
Other variables can influence the window for depreciation. For example, during an economic downturn, Congress may expand how much can be expensed in the year an asset was purchased. Therefore, assets that are normally depreciated over a five- to the 10-year period under normal economic conditions can sometimes be expensed right away when the economy is not doing well.
Employee Education
Companies can deduct the costs of classes and seminars that help develop employees’ skills and continuing education required to keep licenses current.
Employee Retirement Plans
Whether a plan is a pension or a 401(k), any contributions a company makes qualify as business expenses, as do fees paid to plan administrators.
Equipment Purchases and Rental Fees
Equipment gets different treatment, depending on whether it’s rented or purchased.
- Rental costs for equipment can be deducted in the year they were paid.
- For purchased equipment, up to $1.08 million can be deducted in the year of purchase, under Section 179 of the tax code. More expensive equipment must be depreciated over time. An exception to this is if an asset qualifies for bonus depreciation, which allows an organization to expense the cost of an asset in the year it was purchased. Currently, the bonus depreciation deduction is 100%, though this is a temporary rule requiring periodic renewal by Congress.
Maintenance and Repair
The cost of equipment maintenance and repairs is deductible, along with the cost of routine maintenance of the real estate, including mowing and landscaping services.
However, repairs that increase a property’s value may not qualify as expenses. Often, they must be categorized as capital improvements and depreciated over several years.
Home Office
Business owners who dedicate a part of their home exclusively to a business can claim several kinds of household expenses for a home office. They’ll need to fill out an additional form: Form 8829.
First, an owner calculates what percentage of the overall square footage the office occupies. The owner can then deduct that percentage of their payments for mortgage interest, rent, insurance, property taxes, and utilities.
Insurance
Premiums are deductible, as long as the type of insurance is ordinary and necessary for the business. They can include the following:
- Business insurance, such as liability, hazard, or workers’ compensation
- Property and casualty insurance for properties the business owns
- Health insurance for employees
Internet Services
Internet contracts are deductible, as long as they’re used primarily for business. Internet expenses can also include the costs of websites.
Legal and Professional Fees
A company can claim expenses for money spent on lawyers or other professionals (e.g., accountants) for work related to its business.
Marketing and Advertising Costs
Expenses that promote a business can range from physical materials, such as flyers or direct mail, to TV and online advertising, as well as social media.
Membership Dues
If a company or one of its employees belongs to a professional association, it can claim dues as expenses. The same goes for subscriptions to business publications. However, memberships in social clubs, such as country clubs, don’t qualify.
Mortgage Interest
Like a homeowner, a business can deduct interest payments if it has taken out a mortgage loan to purchase a property.
Office Furnishings
The tax code treats office furnishings as equipment, deductible up to $1.08 million in a year. Furnishings can include not only desks and chairs but also carpets, shelves, lights, and artwork.
Payroll
For employees, payroll expense means wages and benefits reported on Form W-2. For independent contractors, it means payments reported on Form 1099.
Rent
A company can deduct the rental costs for an office, a warehouse or other facility used for the business.
Software
The IRS categorizes computer software as supplies, whether it’s a one-time purchase or a subscription.
Supplies
For tax purposes, supplies are materials consumed and replaced within one year. Examples include pens and paper, printers and ink, and cleaning supplies. Equipment that costs less than $200 can also be expensed as supplies.
Utilities
A company can write off the cost of electricity, heating, telephone, water, and sewer service for any of its business properties.
Resources
The following resources contain additional information on these and other types of business expenses:
- IRS, Publication 535. The federal tax agency’s most up-to-date brochure on business expenses.
- QuickBooks, 2022 List of Small-Business Tax Deductions. A detailed guide to expense deductions that highlights what’s new.
- TurboTax, “Taking Business Tax Deductions.” Information on expense categories from one of the leading tax preparation programs.
- Bench “17 Big Tax Deductions for Small Businesses (2022).” Specifics on the top deductions and how to take them.
- The Ascent, “How to Make a Depreciation Schedule: A Small Business Guide.” A guide that summarizes the complexities of depreciation for small businesses.
Business Expenses for Taxes
Knowing the types of business expenses is only half the tax battle. To take full advantage of them, a company needs to track its expenses throughout the year, making them part of its tax planning.
It’s important to note that reducing taxable income by deducting expenses may, in some cases, reduce a company’s bottom line for financial accounting purposes. Therefore, some companies may choose not to go that route.
Strategies for business expenses for taxes include the following:
Keeping Up-to-Date Records
To claim a business expense for taxes, a company must have documentation that a payment was made and that it had a business purpose. Acceptable forms of documentation include invoices, receipts, canceled checks, and credit card statements.
A business should keep expense records for at least four years after filing a tax return, as the IRS has three years to decide to undertake an audit. For major purchases, it’s good to maintain records for as long as the asset is still in use.
Timing Expenses
A crucial aspect of tax planning is timing. Tax rules allow some flexibility as to when a company incurs and claims an expense, and that flexibility can help reduce a company’s tax bill. Some tactics for timing expenses:
- Postpone or prepay. If a company has already bought enough equipment to approach the $1.08 million threshold, it might postpone further purchases until the following year. Conversely, if it expects to spend more on equipment the following year, it might move some of those purchases to the current year. A similar principle can apply to other kinds of spending. Stocking up on supplies before December 31 can help reduce a tax bill, as can paying insurance premiums early.
- Write-downs. If a company has higher expenses than expected, it can consider writing down assets that have declined in value. Examples are uncollectible debts, obsolete or damaged equipment, or unsellable inventory.
- Employee bonuses. When a business enjoys an especially profitable year, year-end bonuses can qualify as payroll expenses.
Knowing What’s Not Deductible
Although a broad array of expenses are deductible, some are not. To avoid penalties, it’s crucial to know which types of business expenses can’t be claimed at all. Some examples include:
- Federal income tax payments
- Entertainment expenses, such as taking clients to a play or sporting event
- Contributions to political campaigns
- Lobbying expenses
- Fines paid for illegal activities
This is not a complete list, as there are numerous other expenses that are not deductible.
Resources
For further information on using business expenses for tax planning:
- The Balance Small Business, “8 Great Year-End Business Tax Planning Tips.” Practical ideas on timing expenses.
- First State Community Bank, 6-Year-End Tax Planning Tips for Your Small Business. More strategies for scheduling expenses.
- Wolters Kluwers, “Business Deductions Are Critical for Tax Savings.” Explains the nuts and bolts of how to separate deductible from nondeductible business expenses.
How to Categorize Business Expenses for Taxes
Long before tax time, a company should set up an accounting system that categorizes business expenses for taxes in real-time as each expense is entered.
In practice, most firms set up two parallel accounting systems, which may classify the same records into different kinds of categories:
- A financial accounting system helps executives understand operations, set prices and prepare financial statements. It may separate expenses into groups such as manufacturing, labor, selling, administrative and cost of goods sold. This type of accounting is used to supply information about a company’s performance to outside parties, while managerial accounting — which follows similar processes — is used to support decision-making within the organization.
- A tax accounting system follows the expense categories used on Schedule C or other business tax forms.
The development of accounting software has made it much simpler for businesses, especially small ones, to create both kinds of systems. Setting up a tax accounting system typically consists of the following steps:
1. Select Accounting Software
In choosing among the wealth of available packages, a business should start by assessing its needs and asking some basic questions:
- Will the software categorize expenses in ways needed for taxes?
- What other categories will be useful for managing operations?
- Does the software offer industry-specific add-ons, such as point-of-sale for a retailer or insurance billing for a doctor’s office?
- What size computer system and storage will the software require?
- Should the company use the same software as its outside accountant?
A final consideration is that the company’s accounting software should interface with its tax software so that it can import expenses directly into the tax program.
2. Choose an Accounting Method
Before creating expense categories, a business must decide which of the two chief accounting methods it will use:
- Cash accounting records an expense at the time a business pays a bill. Small businesses primarily use this form of accounting.
- Accrual accounting records an expense at the time a business incurs it, such as when it receives an invoice. It’s a more complicated system that larger businesses that operate on credit typically use. Certain companies, such as those that maintain inventory, can only use accrual accounting.
3. Set Up Business Expense Accounts
Accounting software helps a business set up the expense accounts it needs for its taxes and assigns them account numbers.
Depending on the type of business, it may choose different categories for different types of business expenses. For example, a company that provides cell phones to its salespeople might set up a separate expense account for telephone service. A company that has only a landline might categorize it under utilities.
Code Vendor Invoices
The most efficient way to code vendor invoices is to do it ahead of time. When the company sets up a new vendor in the system, it links the vendor to the appropriate expense account.
The alternative is to code each invoice manually when it’s entered into the system — a process that increases the risks of human error.
Resources
To learn more about how to categorize business expenses for taxes:
- ”Business News Daily, “What Business Expenses Do You Need to Track?” Primer on how to track expenses for taxes.
- The Ascent, “How to Categorize Business Expenses.” Step-by-step instructions for setting up tax categories in an accounting system.
- , “How to Choose Business Accounting Software.” Guide to different kinds of software and how to assess needs.
- Investopedia, “Best Accounting Software for Small Business.” Reviews with pros and cons of five top programs.
How to Write Off Business Expenses
A business categorizes its expenses as the year goes along. When it’s time to file taxes, the following is a typical process for how to write off business expenses:
1. Import Data
The accountant imports expense records from a company’s accounting software into its tax software. The accountant can then enter the imported data into the appropriate sections of the company’s tax return.
2. Enter Into Schedule C
In 2021, a majority of businesses — nearly 28 million — filed Schedule C,which applies exclusively to sole proprietors. They transferred the net profit or loss from the last line of Schedule C to Form 1040.
Different types of business expenses get entered into different sections of Schedule C:
- Part II itemizes 23 categories, listing them alphabetically, from “Advertising” to “Wages.”
- A Part II category, “Other,” lets a business enter expenses not covered in the list, such as memberships and dues.
- Two additional kinds of expenses go on other lines of Schedule C: the costs of a home office and the costs of producing goods for sale.
3. Review Expenses
Before completing Schedule C, a tax accountant reviews the underlying expense records to make sure of the following:
- All have been categorized properly.
- All meet the requirements of being ordinary or necessary to be deductible.
If someone other than the company’s accountant prepares the return, a good practice is to have the accountant confirm the expenses as well.
Resources
The following resources contain further information on writing off business expenses:
- NerdWallet, “IRS Business Forms: A Comprehensive List.” Summarizes Schedule C and other forms a business might need to file.
- IRS, 2021 Instructions for Schedule C. Instructions from the IRS.
- Money Crashers, “IRS Schedule C Tax Deductions & Expenses for Small Business Owners.” Line-by-line explanation of which expenses go where.
- IRS, Lesson 2: Schedule C and Other Small Business Taxes. An IRS video course, with 19 lessons on how to fill out Schedule C.
Contributing to the Financial Success of Companies Large and Small
Whether a company is a mom-and-pop or a multinational corporation, claiming eligible business expenses is at the core of effective tax planning.
That’s why a knowledgeable tax accountant is key to the financial health of any business. Accountants can help establish the right accounting system and clarify which types of business expenses a business is allowed to deduct.
The bottom line is simple: The better a company understands business expenses for taxes, the more of its income it gets to keep.