How to categorize bank transactions

To categorize a bank transaction is to write down what the money was for. Your bank statement says “STRIPE TRANSFER” or “AMAZON MKTPL”. A category says “Service income” or “Office expense”.

Most people think the hard part is to choose between two expense categories. It is not. The decision that matters most comes first: is this line income, an expense, or neither?

The short version

• First ask: did the business earn or spend money here, or did money only move?
• Transfers, card payments, owner draws, loans and your personal tax payments are neither income nor expense.
• For real income and expenses, use categories that match the lines on Schedule C.
• Split lines that are part business and part personal.
• Put the same kind of cost in the same category every time.

Words to know

• Category: the label that says what a transaction was for.
• Transfer: money that moves between your own accounts. It does not change your profit.
• Owner draw: money you take out of the business for yourself. It is not an expense (see how to pay yourself as a sole proprietor).
• Schedule C: the IRS form where a sole proprietor reports business income and expenses.

Step 1: Income, expense or neither

These mistakes cost the most:

• A transfer called income makes you pay tax on your own money.
• A credit card payment called an expense counts your spending twice. The purchases on the card are the expenses. A credit card reconciliation finds this error.
• Pay to yourself called wages hides profit. The IRS says a sole proprietor can’t deduct their own salary or personal withdrawals (Publication 334). The Schedule C instructions say not to include amounts paid to yourself as wages (Instructions for Schedule C).
• Federal income tax paid from the business account is not an expense. Publication 334 says: “Do not deduct federal income tax.”
• A loan deposit is not income (Publication 334). Only the interest part of a loan payment is an expense. See interest and bank fees deductions.

For more on draws, see how to record owner draws and contributions.

Step 2: Choose a category that matches the tax form

Schedule C has a numbered line for each common kind of expense. If your categories follow those lines, your year-end Profit and Loss is most of the way to a tax return. Some common lines on the 2025 form:

On the 2025 form, Other expenses moved to line 27b (Instructions for Schedule C). For other costs, use our Schedule C line finder. To decide if a cost counts at all, see what counts as a business expense.

Step 3: Split mixed lines

Publication 334 says that if an expense is partly for business and partly personal, you separate the personal part. The personal part is generally not deductible (Publication 334). Record the personal part as an owner draw.

An example

Maya is a freelance designer. (She is an example, not a real person.) Here is one week of her business account:

She records the Stripe payout at its full $1,500.00, with fees as an expense. A Form 1099-K shows the gross amount, not adjusted for fees (IRS), so her income then matches it.

More than $6,000 moved. Only $1,500.00 of income and $152.69 of expenses reach her Profit and Loss.

A Righto tip

In Righto, when you give the same kind of line the same category a second time, Righto offers a rule. You can also ask your own AI agent, such as Claude Code, to suggest a category for each line. Nothing is saved until you approve it. See how agents work with Righto.

Common questions

How many categories do I need? As few as give you useful reports. Ten to twenty is plenty for most freelancers.

Can I put everything in Other expenses? You can, but it hides what you spend. Schedule C asks you to list each other expense with a description anyway.

What if I chose the wrong category last month? Change it. A category change does not change your bank balance, so your reconciliation stays correct.

What to do now

1. Open last month’s transactions.
2. Find lines that are not income or expense: transfers, card payments, draws, tax payments and loans. Fix those first.
3. Check that each expense category matches one Schedule C line.
4. Split any mixed lines.
5. Write down the choices that took you more than a few seconds.

Righto is free, easy to use and needs no account.

Sources

• Instructions for Schedule C (Form 1040), IRS
• Publication 334, Tax Guide for Small Business, IRS
• What to do with Form 1099-K, IRS