Business expenses are the costs associated with running a business, such as marketing expenses or lease payments for office space. They are often tax-deductible.
Understanding what counts as a business expense and whether one is tax-deductible can help you maximize your tax savings. Anyone with business income, from business owners to freelancers, can benefit.
Here, we’ll review exactly what qualifies as a business expense and how to handle these costs as income deductions when filing your taxes.
Definition and Examples of Business Expenses
Business expenses are the costs businesses must pay to fund their operations. They include a wide range of expenses, including insurance costs, employee salaries, office space rent, and utilities. In many cases, namely when the expense is ordinary and necessary, business expenses are tax-deductible.
Come tax time, you’ll need to distinguish business expenses from other expenses such as capital expenses, personal expenses, or expenses used to calculate the cost of goods sold.
For example, a web designer might have billed clients $100,000 in a year. However that doesn’t mean they earned a profit of $100,000, because they also would have incurred costs to provide their services, such as fees for design software, internet usage, and office space rent.
So the business owner can deduct those costs (or others, such as advertising expenses, payment processing fees, insurance, and more)—assuming they meet Internal Revenue Service (IRS) criteria for being tax-deductible business expenses. That way, the business owner could reduce the amount of federal taxes on their business income.
Some common types of business expenses include:
- Advertising costs
- Employee pay
- Meals (generally, 50% can be deducted)
- Payment-processing fees
- Office rent (home office use may be eligible under certain parameters)
- Vehicle use (certain vehicle rules apply)
How Do Business Expenses Work?
A business expense needs to be “ordinary and necessary” to be tax-deductible. This can vary based on the type of business you run. In some ways, the definition of what a business expense is can be subjective, but the IRS defines it more precisely as being “common and accepted” and “helpful or appropriate for your trade or business.”
In other words, you can’t put, say, your personal vacation expenses on a company credit card and count it as a business expense. That’s because vacations do not count as ordinary and necessary expenses to keep your business functioning.
Generally, business expenses are separate from personal expenses, although it’s possible for expenses to be a mix of both, like a phone bill for service you use personally and for your business. In these cases, you may be able to deduct the percentage of the cost that’s in proportion to the percentage it was used for your business.
Some types of costs associated with operating a business are treated differently for tax purposes. For example, with the cost of business meals, you can usually only deduct 50% of the cost.
Other costs aren’t considered business expenses at all. For example, the cost of goods sold, such as the cost of buying inventory, is generally deductible from your gross business income. However, it’s declared separately from your business expenses.
Likewise, the costs of starting a business, such as the expense for new equipment, registering your business, or advertising that you’re opening a store, can be deductible, but they may be treated differently than regular business expenses. That is also true for organizational costs, or the costs of creating a corporation or partnership.
What Do Business Expenses Mean for Individuals?
If you run a business or are thinking of launching a business, understanding how business expenses play a role in your overall budget can help you make business decisions to maximize your profits.
Knowing what qualifies as a business expense according to IRS standards may also help you reduce your tax bill.
- Business expenses are costs a business incurs, and they are often tax-deductible.
- Business expenses include ordinary and necessary expenses, but they do not include personal expenses or capital expenses.
- Common business expenses include advertising costs, employee pay, leasing expenses, and more.
- Start-up costs or organizational costs such as the costs for establishing a partnership or corporation may also be tax-deductible.