Do you always ask yourself is this a business expense or not? And is it deductible? It’s a common question, especially as tax resources can be a little vague with definitions or by using obscure examples not relevant to your business. One tip is to use the business expense categories, hopefully offered by your local tax body, to categorize them as they incur. This allows you simply to evaluate them once the come in, saving you a lot time by avoiding the hours of documenting boxes of receipts.
What makes an expense deductible?
If the expenses can be attributed to you doing business, it most likely is deductible (at least partially). That’s essentially what the IRS states as deductible business expenses as they….
…must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business.
Do understand that? In normal language, ordinary expenses are fairly simple, they’re the business expenses typical of your industry, and that you probably think of business expenses. Necessary expenses would be better defined as costs required for your business to succeed, such as traveling to a client or tools used (such as FreshBooks) to make your business a success. They need to be both of these for them to a be a tax deductible expense.
The Canada Revenue Agency (CRA) gives an example list that helps get you started (workable for businesses in other countries as well or US Expense Categories here). If you can easy qualify them into one of these categories, they’re likely an ordinary expenses and necessary so you should be able to deduct them. If you have your own sample list, please link them in the comments below.
- Allowance on eligible capital property
- Bad debts
- Business start-up costs
- Business taxes, fees, licences, dues, memberships, and subscriptions
- Business-use-of-home expenses
- Capital cost allowance
- Current or capital expenses
- Delivery, freight, and express
- Fuel costs
- Legal, accounting, and other professional fees
- Maintenance and repairs
- Management and administration fees
- Meals and entertainment
- Motor vehicle expenses (automobile)
- Office expenses
- Prepaid expenses
- Property taxes
- Salaries, wages, and benefits
- Telephone and utilities
- Other expenses
These may not all be directly applicable to your business and you may have some of your own specific categories, but these are fairly exhaustive. Also, if you can quickly determine an expense to be attributable to your personal use, such as that trip to the tropics (Travel), they’re not a business expense. Here are a few examples for a service based business:
Office expenses – No matter what your business is, you have office expenses. They’re typical products or services you use in your office, such as pens and paper that use you every year.
Capital expenses – Capital expenses can vary greatly for each industry, but for a freelancer or agency, these are products, and maybe even services, that you use overtime such as a computer. How you deduct it will depend on how your accounting is setup, so these are best calculated by an accountant / bookkeeper as you receive the benefit from your computer over a few tax years.
Maintenance and repairs – If you’re providing a service based on your time, you likely have very little “maintenance and repairs.” These are mostly related to long term assets that require repairs every year, such as a factory. But if you use your car in your business, than you can likely deduct part of it assuming you use it for personal errands as well.
Bonus: Setup expense categories in FreshBooks
Setting up expense categories in FreshBooks can help you quickly decide whether that expense is a business expense or not as you incur them. This will make tax time reporting really easy as you tracked them all year. You’ll also know where all your money/profit is going – great for going deeper into your business’ financial health.
How do you set up these categories?
- Go to your “Expenses” tab
- Click on the sub-tab “Categories”
- Then click on “+ New Category”
- Write in the Category
- Click “Add Category”
- Repeat until all the categories are in
Special thanks to @adelorenzo for the tip!
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