Do you always ask yourself is this a business expense or not? And is it a deductible expense? It’s a common question, especially as tax resources can be rather vague with definitions. Sometimes they even use obscure examples not relevant to your business. One tip is to use the business expense categories offered by your local tax body. This allows you simply to evaluate them once they come in, saving you a lot time by avoiding the hours of documenting boxes of receipts.
In today’s post, we’ll discuss the basics of deductible expenses and how you can use FreshBooks to make categorization much easier.
What is a Deductable Expense?
If the expenses can be attributed to you doing business, it most likely at least partially deductible. 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.
Putting aside the jargon, it simply means: ordinary expenses are typical things other business owners in your industry purchase. You’re probably already counting these things as expenses.
Necessary expenses would be better defined as costs required for your business to succeed. This includes things like traveling to a client or tools you use (such as FreshBooks).
In order to qualify as a tax deductible expense, the purchase must fall into both categories.
If you can easy qualify them into one of these categories, they’re likely 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 over time 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, then 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 +New Expense
- Then click on Category
- Choose Your Top-Level Category
- Select Edit This List
- Add your new subcategory
- Repeat until all the categories are in
Special thanks to @adelorenzo for the tip!