Certain deductible business expenses can help reduce the company’s overall expenses and increase profitability. Every business should track its expenses for tax purposes, be it a large enterprise or a small street shop.
When preparing the overall tax returns, the business subtracts the expenses from revenue to arrive at the net taxable income. The business expenses are also referred to as deductions.
Therefore, one should know which expenses are tax deductible and how they can benefit from them. This is also important to accurately file taxes. Before we list what business expenses are tax deductible, let us see what they exactly are.
Understanding Deductible Business Expenses (Write-Offs)
One must refer to the IRS guidelines for business expenses for all tax purposes. The business expenses, according to the IRS, are the expenses that are ordinary and necessary.
The term ordinary here means the expense should be quite common in the business industry. The term necessary entails that the expense in question is just and important for a business and has an integral role to play in its functioning.
For example, inventory or rent are some examples of tax-deductible expenses. Section 162 of the Internal Revenue Code clearly outlines the standard business deductions, which include expenses for general and administrative purposes, business travel, business entertainment, automobile, and employee benefits.
The company doesn’t have to pay taxes on tax-deductible expenses when filing tax returns. This means when calculating the taxes, the company subtracts deductible business expenses from the taxable income.
Kinds of Business Expenses
You can divide the business expenses into many categories, depending on the criteria.
The business expenses fall into two categories, namely capital expenditures and operational expenditures. However, as per the frequency, the business expenses are categorized into fixed, variable, recurring, and non-recurring expenses.
However, let us look at the function and divide the business expenses into these categories.
1. Capital Expenses (CapEx)
The expenses used for the purchase, modification, and management of the capital assets are called capital expenses.
Capital expenses group the cost spent on acquiring, purchasing, and maintaining assets such as buildings, machinery, company vehicles, digital infrastructure, property, and technology.
It is abbreviated as CapEx. A subtle indication of capital expenses is that they are incurred for the long term.
Capital expenditures are often a one-time investment in assets that are non-consumable. Such expenditures are primarily over buying or investing tangible assets like raw materials, real estate, property, plant, and equipment. Moreover, intangible assets like licenses and patents also fall under capital expenditures.
One should note that the costs of repairing or maintaining assets like equipment do not fall under capital expenditures. They take a different place in the company’s statement, in the column of the operating expenditures.
Let us look at some types of capital expenditures.
The capital expenditures incurred on improving and enhancing the existing assets are termed as upgrades Capex.
The acquisitions include investing in new assets such as patents and real estate. Some examples of acquisitions Capex are acquiring a new business or starting a new business.
Renovations Capex includes the cost of improving the life and long-term value of obsolete or old assets.
When you modify an asset for a use that is different and new, the cost incurred will be termed as adaption Capex.
Examples of CapEx
- Real estate, including land or a new building for an organization
- Machinery and equipment used in operations
- Computers and other equipment that make up a company’s IT infrastructure
- The purchase of another company
- Cars and trucks used by employees or to transport goods
- Patents utilized in product development
- licenses for goods and services having long-term value.
- Furniture, including office chairs, desks, and couches
2. Operating Expenses (OpEx)
Operating business expenses are incurred during normal business operation operations and are abbreviated as OpEx.
The expenses directly involved in the manufacturing, producing, and facilitating of goods and services fall under operating expenses.
The operating expenses can include equipment and inventory costs, marketing, rent, payroll, and costs spent on Research and Development.
Operating expenses are incurred during normal operational or commercial activities. The vital operational activities vary from industry to industry.
Some operational activities in one industry might be categorized as an investment in another industry.
However, the operating expenses exclude the Cost of Goods Sold (COGS) instances. Usually, a company includes costs like direct material, repair of facilities, and taxes on produced units in OpEx.
The business does this expand the operating budget and attract larger investment in the near future.
Examples of OpEx
- Office supplies
- Property tax
- Accounting fees
- License fees
- Direct mailing cost
- Advertising cost
- Sales commissions
3. Non-Operating Expenses
The additional costs incurred over the operational expenses in funding the functions required to support the operations and financial health of the business.
The non-operating expenses are not directly incurred in facilitating the production or manufacturing of the products and services.
Some of the non-operating expenses are inventory write-offs, lawsuit settlements, interest payments, depreciation, etc. The non-operating expenses are not used to fuel the core business operations.
Non-operating expenses are the costs that are kind of uncommon or irregular in the industry. A business must record the non-operating separately from the operating expenses.
This can be fruitful for clearly outlining the financial obligation of the company to the shareholders and investors. The business can subtract non-operating costs from the operating profit to estimate the potential earnings.
Benefits and Role of Reporting Non-Operating Expenses on Balance Sheet
The importance of balance sheet for a business are many and can’t be ruled out. Clearly reporting the non-operating expenses accurately on the balance sheet has the following benefits:
- The non-operating costs allow the business to generate accurate financial reports.
- Exhibiting non-operating expenses such as bonuses, loan interest, and employee benefits increases the company’s reputation.
- Transparency in financial transactions and statements builds positive bonds with existing and potential investors.
- The non-operating costs have a critical role in analyzing the performance of the business and estimating its earnings.
- The detailed listing of non-operating costs allows the company to track the unwanted expenses and devise a strategy to minimize them.
1. Incidental Expenses (IE)
One thing to know about the incidental expenses is that they are primarily unplanned and unpredictable. Incidental expenses are small costs or gratuities.
Most of the incidental expenses are trivial, such as entertainment expenses, auxiliary costs in business travel and trips, cost of room service, staff, and so on.
It is hard to account for every single business expense, and some expenses are so minor and unpredictable.
These are grouped as incidental expenses, generally arising during conducting business or business travels. The deductions on the unexpected expenses are minimal.
For example, the Internal Revenue Service allows a maximum deduction of USD 5 for every day of travel during business trips.
It is quite important for a business to understand incidental expenses as it can help them track or recoup the expenses.
A company must accurately track the incidental expenses as they often has fraudulent activities associated with them. However, that is hard to do in a large enterprise where the number of bills and receipts is too high to verify. Moreover, given the small amounts, the business might not require to produce the receipts to claim these compensations.
2. Costs of Goods Sold (COGS)
The costs of goods sold (COGS) include all the direct expenses of conception and manufacturing of the products. Therefore, any direct expenses involved in producing and manufacturing the goods and services are termed COGS.
Some examples are the cost of paying employees, raw materials, factory, packing, machinery, etc. The cost of goods sold doesn’t include the expenses for sales, marketing, or distribution of the product.
A critical difference between the cost of goods sold (COGS) and operating expenses (OpEx) is that OpEx also lists the costs that are not directly associated with the production of goods and services.
However, you should note that COGS must not include the cost of producing the goods or services the business didn’t sell in the fiscal year.
COGS is recorded as a business expense on the income statements precisely because it is the cost of doing business. Accurately outlining the COGS helps calculate the gross profit and gross margin.
If the COGS is high, the gross margin would be low. Therefore, for higher profitability, you should keep the COGS low.
Deductible and Non-Deductible Expenses
While you will find most of the business expenses tax deductible, there are some business expenses you cannot write off. We call them the non-deductible expenses. Let us take a look at what business expenses are tax deductible and which ones aren’t.
Deductible Business Expenses
Non-Deductible Business Expenses
|● Marketing and advertising
● Interest and bank fees
● Expense reimbursement Commissions
● employee costs for education
● employee advantages
● Mortgage obligations
|● Deconstruction costs or losses
● Education costs
● Government fines and penalties
● Unlawful actions
● Lobbying costs
● Contributions to politics
Moreover, business owners cannot claim tax deductions on personal or non-business expenses. They can’t claim deductions on penalties, fines, and lobbying expenses.
Top-notch Tax Services for Businesses
Precisely outlining the deductible business expenses and benefitting from them is a prerequisite to benefitting from them. However, that is not possible without accurately entering the expenses and strategically planning your taxes. This is why a company needs accurate accounting and taxation services.
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