An Easy Solution to Organized U.S. Taxes: Business Expense Categories

Make tax time less hectic—organize your expenses by categorizing them in FreshBooks!

When tax season comes around each year, do you spend hours sorting through receipts or organizing expense categories because they’ve been lumped into one catchall grouping?

Business expenses can be confusing for freelancers and new small business owners because many tax resources are rather vague with their definitions. They might even use obscure examples irrelevant to your business.

To avoid confusion, you should set up expense categories for your business based on categories offered by your local tax body or ones that are common to others in your industry. Expense categories allow you to easily sort and classify expenses as you spend money, saving you a lot of time by avoiding the hours of sorting boxes of receipts.

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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 Deductible Expense?

If it can be attributed to a business with the intention of making a profit (as opposed to a hobby), the expense is most likely at least partially deductible. In the U.S., the IRS specifies that to be deductible, expenses must “be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business.”

Jargon aside, this simply means ordinary expenses are things other business owners in your industry typically purchase. For instance, a bookkeeper would normally buy computer software, office supplies and advertising. 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 business travel or tools for work. A bookkeeper might be able to pay millions of dollars to advertise during the Super Bowl and categorize it as a normal expense, but is such an expensive ad necessary? Chances are an IRS auditor would say no.

Expense Categories You’ll Find in FreshBooks

Here is a list of commonly used expense categories. These may not all be directly applicable to your business, and you may have some of your own specific categories, but this list is fairly exhaustive for small business owners.

  • Advertising
  • Car & Truck Expenses (including: gas, mileage, repairs, vehicle insurance and vehicle leasing)
  • Contractors
  • Education & Training
  • Employee Benefits (including: accident insurance, health insurance and life insurance)
  • Meals & Entertainment
  • Office Expenses & Postage (including: hardware, office supplies, packaging and postage)
  • Other Expenses (including: bank fees, commissions and wages)
  • Personal
  • Professional Services
  • Rent & Lease
  • Supplies
  • Travel (including: airfare and lodging)

Drawing the Line Between Assets and Deductible Expenses

Occasionally you might spend money on something in your business that seems like an expense, but you’re actually purchasing an asset.

Furniture and Equipment

You may buy computers, furniture, printers or other types of equipment for your business. These items are expected to last longer than one year, so they are assets, not expenses. Instead of expensing the cost of the furniture and equipment, you would “capitalize” the purchase as an asset on your balance sheet, then write off the cost as a depreciation expense over the asset’s useful life.

Capitalization and depreciation are complex. You can check out IRS Publication 946 for more information, but you may want to consult with an accountant or bookkeeper to make sure you’re following the rules.

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Set up Expense Categories in FreshBooks!

Setting up expense categories in FreshBooks can help you quickly identify and organize business expenses throughout the year. This will also make tax time reporting a breeze.

Not to mention the peace of mind that comes from knowing where all your cash and profits are going—which is great for going deeper into your business’ financial health.

In FreshBooks, categories can easily be set up whenever you log a new expense. So how do you set them up?

  1. In your FreshBooks account, go to the Expenses tab
  2. Click on New Expense
  3. When the Expense form pops up, click on Choose a Category
  4. Choose the appropriate Category from the drop-down, (your receipts will appear color-coded based on the chosen category)
  5. Log the rest of your expense

Remember to keep documentation for all your business expenses, regardless of the amount. If you are ever audited, it is your responsibility to substantiate all of the entries and deductions on your tax return. Entries in your small business bookkeeping software and even bank statements are not enough. You should maintain receipts and other records to document your business’ purchases and sales.

Generally, the IRS requires that you keep records to support your income and deductions for three years from the date you filed your return. However, they can extend the statute of limitations to seven years if they believe you did not report all of the income you should have reported, and your unreported income is more than 25% of the gross income shown on your return.

This is from the FreshBooks archive and was originally published in March 2016.

about the author

Freelance Contributor Janet Berry-Johnson is a CPA and a freelance writer with a background in accounting and insurance. Her writing has appeared in Forbes, Parachute by Mapquest, Capitalist Review, Guyvorce, BonBon Break and Kard Talk. Janet lives in Arizona with her husband and son and their rescue dog, Dexter. Outside of work and family time, she enjoys cooking, reading historical fiction and binge-watching Real Housewives.