What counts as a business expense?

A business expense is money you spend to run your business. Software, ads, insurance and payment fees are common examples.

When you work for yourself, you take business expenses off your income before tax. Lower profit means less income tax and less self-employment tax. But only real business costs count. Personal costs do not, even if they help you work.

The short version

• A business expense must be ordinary and necessary for your work (IRS, Publication 334).
• Personal, living and family costs do not count.
• If a cost is partly personal, only the business part counts.
• Business meals are usually only 50% deductible. Entertainment is not deductible.
• Things that last for years, such as a laptop, are usually not deducted the same way as supplies.
• Your own pay, income tax and loan repayments are not business expenses.

Words to know

• Ordinary: common and accepted in your field of business.
• Necessary: helpful and appropriate for your business. The IRS says it does not have to be indispensable (IRS).
• Deduct: take a cost off your income for tax.
• Capitalize: record a long-lived purchase as an asset, then deduct it over time.
• Owner draw: money you take out of the business for yourself.

The personal line

The test is not “does this help me work?” Food, rest and clothes help everyone work. The test is “does this cost exist because of the business?”

A gym membership, a streaming service and lunch alone at your desk are personal. A coat you could wear anywhere is personal, even if you wear it to meet clients.

Costs that are partly personal

Some costs are both. A phone or a car is often used for work and for home. The IRS says to separate the personal part from the business part. The personal part is generally not deductible (IRS).

• For a phone, use a fair business share that matches how you use it.
• For a car, use business miles from a mileage log. Driving from home to a regular workplace is commuting, and commuting is personal.
• For a room at home, see the home office deduction, or try the home office deduction calculator.

Meals and entertainment

In most cases you can deduct only 50% of business meal costs (IRS). A lunch with a client to talk about a project is a business meal. Entertainment, such as concert tickets for a client, is on the IRS list of costs you cannot deduct. A business gift is different: you can deduct up to $25 for each person each year.

Things that last

Publication 334 says that you generally must capitalize the cost of equipment and furniture used in your business. But if you choose the de minimis safe harbor, you can deduct tangible property up to $2,500 per item or invoice (IRS). For larger items there are other rules. In your books, record equipment as equipment, not as supplies, so your tax preparer can apply the right method.

Money out that is not an expense

• Paying yourself. For a sole proprietor, a draw is not an expense. See how to record owner draws.
• Federal income tax. Publication 334 says do not deduct it.
• Loan repayments. The interest can count. Paying back the amount you borrowed does not.
• Transfers. Moving money between your own accounts is not spending.
• Fines. Penalties and fines paid to a government because you broke the law are not deductible (IRS). A parking fee at a client’s garage is fine. A parking ticket is not.

An example

Maya is a freelance designer. (She is an example, not a real person.) Here is part of her March:

Her deductible total from this list, with the monitor, is $571.

A Righto tip

The rules are simple. The hard part is the pile of bank lines. Righto is a free accounting app for Mac. You import your bank and card statements as CSV, OFX or PDF and give each line a category. A personal charge on the business card goes to Owner Draw, so it stays out of your expenses. The Profit and Loss report then shows your real expenses. Our Schedule C categories tool shows where each kind of cost goes on Schedule C.

Common questions

Can I deduct something I paid for with my personal card? Yes, if it is a real business cost. Record it in your books and keep the receipt.

Do I need a receipt for every expense? You need records that support it. See do I need to keep receipts and how to track business expenses for taxes.

Are clothes ever deductible? Clothes you could wear anywhere are personal. Ask a tax professional about uniforms or protective gear.

What to do now

1. Open last month’s bank and card statements.
2. For each line, ask: would I have spent this without the business?
3. Move personal charges out of business categories.
4. Split costs that are partly personal, and keep a note of how.
5. Mark large purchases as equipment.

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

Sources

• Publication 334, Tax Guide for Small Business, IRS