What are business expenses?

Updated: November 9, 2024

Business expenses definition and meaning

Business expenses are costs that companies incur to support their operations, including rent, payroll, inventory, insurance, travel and entertainment, business meals, and any other investments to keep the organization running. Understanding business expenses is critical to managing cash flow effectively and lowering taxes.

More about business expenses

Internal Revenue Code (IRC) Section 162 includes detailed IRS guidelines for business expenses, which are defined as ordinary and necessary costs incurred to operate a business. “Ordinary” business expenses are common and widespread in a particular industry or trade, while “necessary” business expenses are appropriate and useful for a particular business.

Business operating expenses fall into three broad categories:

1. Fixed business expenses occur on a regular basis and are consistent from month to month. Rent, payroll, and insurance premiums are good examples of fixed expenses.
2. Variable business expenses occur on a regular basis but change from month to month. Inventory, utilities, travel and entertainment, and business meals are good examples of variable expenses.
3. Periodic business expenses occur occasionally, not on a regular basis. Equipment repairs and maintenance, advertising and marketing, and year-end employee bonuses are good examples of periodic business expenses.

For accounting purposes, business expenses are recorded on the profit and loss (or income) statement and subtracted from revenue to arrive at a business’ net profit or loss. If they meet the IRS definition of ordinary and necessary, business expenses can be either fully or partially deducted from revenue, which will reduce a company’s taxable income and tax liability.

Business expenses that are tax-deductible

Here are some common business expenses that can be fully or partially deducted from income taxes:

The home office deduction and depreciation

Owners who operate a business out of their home may be able to deduct some housing costs by claiming the home office deduction. These include mortgage interest, utilities, property taxes, and home maintenance and repairs. To determine the deduction amount, divide the total home square footage by the square footage of the area that’s used exclusively for business. So if 250 square feet of a 2,500 square foot home is used exclusively for business, the owner could deduct 10 percent of qualifying housing costs via the home office deduction.

Also, some business expenses are capitalized and depreciated (or deducted) over a number of years. These typically include large fixed assets that won’t be consumed within one year such as property, furniture, computers, equipment, and vehicles.

Generally accepted accounting principles (GAAP) allow owners to choose from one of several different depreciation methods, including straight-line, double-declining balance, modified accelerated cost recovery system, and units of production depreciation. Accounting software can help determine the correct depreciation deductions.

Business expenses that are not tax deductible

Here are some business expenses that cannot be deducted from income taxes:

• Demolition expenses or losses
• Fines and penalties
• Lobbying expenses
• Political contributions

Also, any personal expenses that are not directly related to the operation of a business are not deductible. This includes meals where business is not conducted or discussed.

How to keep track of business expenses

It’s a good idea to track and document business expenses carefully so you are prepared at tax time. The first step is to separate legitimate business expenses, which are tax-deductible, from personal expenses, which aren’t tax-deductible. In short, if an expense is incurred in the ordinary course of running your business, it is a business expense that can be deducted. But if it has nothing to do with operating your business, it is a personal expense that can’t be deducted.

Another best practice is to keep printed receipts for any business expenses you plan to deduct for at least three years in case you are audited by the IRS and have to document the expenses. Many businesses use accounting software to help keep track of deductible expenses, but it’s still smart to retain printed receipts for substantiation. Alternatively, you could scan printed receipts and store digital copies electronically.

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