Understanding how to categorize expenses and assets according to IRS guidelines makes it easier for businesses to avoid surprises at tax time — and establish day-to-day business plans that help manage cash flow.
By categorizing expenses and assets correctly and calculating deductions in accordance with the rules of accounting and the IRS, businesses may even qualify for a more favorable tax bracket, which can provide more savings. A few considerations that can affect a business’s tax obligations are:
- Whether the business will recover the cost
- Which limits for deductions apply
- Whether income is passive, or not actively managed
For small businesses, beneficial practices like carefully tracking expenses and assets take on even greater importance. After all, the U.S. Small Business Administration (SBA) reported in 2021 that only about half of all small businesses survive for longer than five years. Investopedia lists issues with cash and planning among the top reasons that many of these businesses fail.
What Is a Business Expense?
One of the first issues to consider when learning how to categorize expenses and assets is the definition of a business expense. A business expense is what a company spends or how much cost it incurs as part of its efforts to generate revenue.
Expenses that meet the IRS criteria for being “ordinary and necessary” qualify a business for tax deductions, meaning that the company can reduce the dollar amount of its taxable income. Business expenses use cash that an organization has readily available or obtains through a line of credit.
Operating Expenses vs. Nonoperating Expenses
All types of expenses generally fall within two broad categories: operating and nonoperating.
- Operating expenses are business expenses associated with a company’s main activities, such as the cost of goods sold, rent and administrative fees. Fixed operating expenses, such as overhead and equipment, don’t change, while variable operating expenses fluctuate depending on production.
- Nonoperating expenses are business expenses that aren’t related to a company’s core operations, such as costs for taking out loans.
4 Common Types of Business Expenses
What are business expense categories that businesses should track? The four most common types of business expenses include:
Typically, businesses can classify the amount they pay employees for their services as deductible. The payment may be in cash, property or in-kind services.
Qualifying new and used equipment is a business expense. The company must purchase the equipment specifically for business use, however.
The decline in value and usefulness of equipment over time is called depreciation. This expense typically spans multiple years, with each year’s amount representing how much of the equipment’s value the business uses during that year.
Payments to Suppliers and Manufacturers
When considering how to categorize expenses, businesses should also keep in mind any payments to suppliers and manufacturers. These payments may be to a person, an organization or another entity that provides the business with a product or service it needs to operate. For example, supplier and manufacturer payments from restaurants might include those to food service product distributors.
Expense Categories for Small Business
Companies of all sizes can benefit from deductions for business-related expenses, but there are 12 that commonly apply to small businesses. A sole proprietorship (a business that one person owns and operates) and a partnership (a business that more than one person owns and operates) frequently use the following key expense categories for small businesses:
Advertising and Marketing
All advertising and marketing costs are deductible, including expenses for attracting or retaining the business’s customers, as long as the fees aren’t for activities that aim to influence legislation or fund political activities. These costs could relate to activities such as:
- Producing business cards
- Placing television, print, and online advertising
- Designing a company logo
- Coordinating social media marketing
Small business insurance protects against property damage and lawsuits. Many state laws as well as regulations and contracts require businesses to have this coverage. The following are among the types of insurance whose premiums are tax deductible:
- General liability or malpractice
- Business interruption
- Workers’ compensation
- Business vehicles
- Furniture, equipment, and facility
- Employee health, dental, vision, and life
Generally, 50% of expenses for food and beverages purchased as part of doing business are deductible. These expenses shouldn’t be excessive for the circumstances, and the business owner or an employee must be present at the meal.
Meals that the business provides to employees, such as office parties or dinners for after-hours work, are 100% deductible.
Business Use of a Car
Businesses can deduct expenses related to operating vehicles used for work from their taxable income. If the vehicle is solely for business use, all costs associated with driving and maintaining the vehicle are deductible. If the vehicle is for business and personal use, only expenses associated with work are deductible.
Depending on which option provides greater tax savings, businesses can deduct vehicle expenses according to the following formulas:
- Standard mileage rate, which pays a standard amount that the IRS establishes each year for each mile driven for business
- Actual expenses, which account for all costs of vehicle operation, including gas, maintenance, insurance, and registration
Rules related to depreciation generally require companies to spread the cost of equipment over all the years it’s in use, instead of deducting the full price from taxes in a single year. These guidelines apply only to equipment that a business will use for more than one year.
Businesses can write off 100% of equipment costs in the year of purchase in some instances. For example, businesses may be able to deduct the full expense for equipment that costs less than $2,500.
Some of the expenses associated with maintaining a home office for business are deductible. The area must be used exclusively for office work and must be the primary location for the business’s work. Deductions may total $5 per square foot of office area, or it may be a percentage of all home-related costs, according to the size of the office.
Business-related legal fees are also deductible, even in cases that end in a judgment against the company. These fees could relate to:
- Addressing whistleblower complaints
- Responding to unlawful discrimination claims
- Resolving tax issues
Expenses for office supplies are eligible for deduction from taxable income. These supplies can be for use in areas such as offices, restrooms and break rooms. Examples of deductible office supplies include:
- Printer paper
- Paper clips
- Cleaning products
Phone and Internet
Expenses for phone and internet service are collectively a common expense category for small businesses. The cost of cellphones and internet use is deductible according to the percentage of their use for business. Landline phones generally aren’t tax deductible unless they’re a second landline for business use only.
The costs of renting a facility or equipment also qualify as deductions. These expenses are separate from rent for home offices, which are classified as home office costs.
Salaries and Benefits
To classify employee salaries and benefits as deductible, they must be for employees other than sole proprietors or partners. In a limited liability company (LLC) business structure, the employees can’t be LLC members. Among the types of salaries and benefits are:
- Fringe benefits
- Vacation allowances
Costs associated with launching a business are another common expense category for small businesses, although the IRS establishes limits each year for deductible amounts.
Startup costs are those that a business typically would incur as part of its regular operations, but it takes on these expenses before opening. Because the expenses don’t represent a cost to the business, the IRS counts these costs as capital expenses with deductions that generally occur over several years. Among the fees that are 100% deductible are those related to:
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Small business owners may miss claiming the following deductions for allowable expenses on their tax returns, according to the Accounting Institute for Success. 1. Charitable contributions by completing IRS Schedule A with Form 1040. 2. Child dependent care expenses from 20% to 30%, depending on adjusted gross income 3. Retirement contributions paid to employee accounts and to the business owner’s own account. 4. Health insurance paid on behalf of employees and a self-employed person’s spouse and family.
12 Business Expense Categories for Large and Small Firms
Businesses of all sizes need to manage how they track costs using some key business expense categories. To assist in determining how to categorize expenses, the following are 12 of the most common expense categories for large and small firms:
The term “bad debt” can refer to a loan made to an employee, a client or a supplier that wasn’t repaid. Another example is making a credit sale to a customer who didn’t pay for the product or service. These amounts are eligible for tax deductions, as long as the business has proof that the debt was for business purposes and not a personal loan.
Businesses that suffer damage, destruction or loss of property because of an unexpected event can classify expenses related to these losses, called casualty losses, as tax deductible. These losses don’t refer to typical wear and tear. Examples of events that could cause this type of damage are:
Requirements for claiming deductions vary according to the type of casualty. Generally, however, for property that isn’t completely destroyed, the IRS bases deductions on the value of the property.
Interest on loans or credit cards is another business expense category for small and large companies. This interest can include lines of credit and mortgages on real estate for business purposes, and it can be 100% deductible.
Businesses can claim contributions to charitable organizations. The IRS typically limits this to 60% of taxable income, although the cap can be lower in some cases.
Payments to independent contractors and freelancers who provide services to a business fall within the category of contract labor expenses. These costs may be a deduction as a business expenses.
Training and education for the business owner or employees can also be a business expense. Examples of business-related education expenses are:
- Industry-relevant classes and workshops
- Business conferences and webinars
- Certification programs
- Professional publications subscriptions
Employee and Client Gifts
Gifts to employees, employees’ families, and customers are tax deductible as well. The IRS limit for annual deductions is $25 per individual.
Foreign Earned Income Exclusion
U.S. citizens living in a foreign country may qualify for a foreign earned income exclusion, which counts their pay for overseas work as a deduction. To be eligible for this exclusion, the employee must meet one of these criteria:
- Live in a foreign country for the entire tax year
- Be present in the foreign country for at least 330 days during any consecutive 12-month period
Businesses may deduct investment income, including dividends and interest, as a business expense category in some circumstances. The term “investment interest expenses” refers to interest on a loan associated with an investment, such as interest on an investment property. To qualify, the income can’t be passive, meaning that investments the business doesn’t actively manage aren’t eligible for deduction.
Expenses for buying or renting a new business location are tax deductible. Also included in moving expenses are those related to transferring business equipment, inventory and supplies to another facility. For sole proprietorships or partnerships, the criteria for eligibility include moving at least 50 miles and working at least 39 weeks in that location after the move.
Companies and their employees can deduct retirement plan contributions from business income, within contribution limits that the IRS establishes each year. Retirement plans whose contributions qualify for deduction are:
- Individual retirement account (IRA)
Costs for business travel to a state other than where an employee resides are 100% tax deductible. Among the eligible travel expenses are:
- Ground transportation costs
- Parking and toll fees
- Hotel costs
Types of Business Assets and How to Record Them
Along with understanding how to categorize expenses, small and large firms should know the types of business assets. Defined as items of value that a business owns, assets are vital for organizations to operate. For businesses, assets typically cost more than $2,500. The IRS refers to assets as property.
Assets can be short term, or current, which means that they’re held for less than a year, or they can be long term, or fixed, which benefits the business for longer than a year.
Characteristics of an Asset
To qualify as a business asset, an item must have three characteristics:
- The business must own or control the item.
- Economic value. The business must be able to sell the item for cash to support growth.
- The item must have the ability to generate monetary value in the future.
Examples of Assets
Assets run the gamut from buildings to intellectual property. The following are types of business assets:
Also known as “cash and equivalents,” these are securities with low risk and low return. Examples of these investments include:
- Bank certificates of deposit
- Bankers’ acceptances
- Treasury bills
- Money market accounts
The term “accounts receivable” (AR) refers to the amount of money that customers owe for goods or services that a business already has delivered. This total equals all outstanding payments for purchases made on credit.
Another type of business asset is inventory. This asset includes the following:
- Raw materials used in production
- Items still in production
- Goods ready for sale
Investments are assets a business purchases to generate income or appreciate in value. This asset involves providing capital with the hope that the return will be greater than the original investment. Examples are:
- Real estate
Property, Plant and Equipment
Property, plant and equipment (PP&E) is a type of long-term physical asset whose economic value lasts beyond a year. PP&E items include the following:
Patents, a form of intellectual property, are intangible assets that give a business exclusive rights to an invention, design or process for a set time period. Companies can calculate their value according to the type of patent and whether it’s likely to produce returns.
Resources About Tracking Business Assets
Various resources are available for learning more about the types of business assets and how to record them for tax purposes. Among the sources for business asset information are:
- The Balance Small Business — This source lists 10 facts about business assets and how to record them.
- FreshBooks — This source provides definitions of business assets and how to track them.
- Indeed Career Guide — This source provides an overview of business assets and how to list them on corporate balance sheets.
- Marcus Lemonis — This source offers information about the types of assets and how to identify them.
Why the Classification of Assets Is Essential for Taxes
Buying or selling business assets affects a business’s financial health and its tax obligations. When a business converts assets to cash, they become income — and the IRS taxes most types of income. Companies need to understand their own assets’ classifications and track them accordingly.
Three classifications of assets exist. Businesses can classify assets according to their:
- Convertibility — How quickly a business can convert an asset into cash
- Physical existence — Whether the asset has a physical form (tangible) or not (intangible)
- Usage — Whether the business regularly uses the asset as part of its business operations
Current Assets vs. Fixed Assets
The basic difference between current and fixed assets is their convertibility. The definitions of current assets and fixed assets are as follows:
Current assets typically can be converted to cash in less than a year. Examples of current assets are:
- Accounts receivable
- Cash accounts
- Cash equivalent accounts
Fixed assets generally are more expensive items that businesses hold for more than a year. These assets are sometimes called noncurrent assets. Fixed assets include:
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The IRS identifies six general categories of non-real estate assets for depreciation claims on the business owner’s taxes. The three most common allow the property to be depreciated over three years, five years or seven years, according to Intuit and Young and the Invested. Three-year property: livestock, tractors, some manufacturing tools. Five-year property: automobiles, light trucks, computers. Seven-year property: office fixtures and furniture, equipment.
Resources on Assets Classification and Taxation
Businesses seeking information about classifying their assets and the types of tax deductions they can seek can turn to resources such as:
- com — This resource describes business assets and available tax deductions.
- The Balance Small Business — This resource provides answers to questions about how business assets affect taxes.
- IRS — This resource explains how to depreciate property for tax calculations.
- TurboTax — This resource lists the information required for compiling business taxes, including asset and depreciation details.
Writing Off Business Expenses: Tips, Strategies and Resources
As part of tracking expenses and assets, businesses should note which expenses qualify for full or partial deduction. The following tips and best practices for writing off business expenses can make it easier to seek deductions:
How to Write Off Business Expenses
Three key steps are involved in determining how to categorize expenses and submit them to the IRS as tax deductions. Anderson Advisors, which provides tax guidance, recommends that businesses follow this process:
1. Identify Qualifying Expenses
Enter each calendar year with an understanding of business expenses that the IRS accepts as deductions. Using accounting software can help with tracking expenses throughout the year. Carefully recording each expense — no matter how small — can make a difference in the tax write-offs a business may claim in a year.
2. Total the Qualifying Expenses
After tracking business expenses throughout the year, total them. Use accounting software or manually add amounts from receipts to determine the total.
3. Note the Total in Tax Forms
Record business expense totals on tax forms. For filing personal income taxes for self-employment or for operating a business as a sole proprietor or an LLC, use Schedule C (Form 1040). For businesses structured as corporations, use a corporate tax return (Form 1120).
Tips for Writing Off Business Expenses
Categorizing expenses and assets — and seeking tax write-offs — is easier if a business carefully tracks its costs throughout the year. Tips for simplifying the tabulation of expenses and recording deductions include:
- Establish a bank account and credit card solely for business use. This helps keep personal and business expenses separate, and it makes it easier to monitor purchases throughout the year.
- Note expenses as they occur, making it easier to retrieve the information when completing tax forms.
- Keep in mind whether expenses are deductible. For example, costs for out-of-state business travel typically are 100% deductible. Charitable contributions generally are only partially deductible. Expenses over the $25 limit for gifts to individual clients aren’t deductible at all.
- Understand which IRS form to use in submitting tax information according to the type of business that incurs the expenses, whether it’s Form 1040 or corporate tax forms.
- Stay abreast of tax rules for retirement contributions. The designation of self-employment 401(k)s as a business expense, for example, is due to a recent tax code change.
Make Tax Planning a Key to Your Business’ Success
Correctly categorizing expenses and assets can help businesses qualify for money-saving tax deductions and plan for expenses throughout the year. A clear understanding of which business expenses to deduct and which assets to report is critical as businesses track expenses to reduce their tax burden — and boost their profitability.
Accounting Institute for Success, “Small Business Tax Deductions in 2022”
Intuit TurboTax, “Depreciation of Business Assets”
Young and the Invested, “MACRS Depreciation, Table & Calculator: The Complete Guide”