Categorizing Expenses for Better Tax Returns

Tax season is like allergy season. Both reemerge each year, whether you like it or not, so you might as well prepare yourself and look for ways to minimize the negative effects. And a key element of tax preparation is categorizing your expenses.

Who knows? Handle things right and you may even find yourself looking forward to the next tax season (though the same can obviously never be said for allergy season). When your expenses are organized, you’ll be able to cruise through your tax reporting and be in a better position to get deductions.

Also known as write-offs, tax deductions are expenses that can be deducted from your overall tax bill. Subtracting the qualified expense from the taxable income you’re reporting leads to a correspondingly lower amount you will owe.

The IRS is understandably interested in what expenses you plan to deduct. For this reason, the agency lays out robust guidelines.

“To be deductible, a business expense must be both ordinary and necessary,” explains the IRS in a general statement on their website. “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. An expense does not have to be indispensable to be considered necessary.”

Organization Is Key to Success

Running a small business involves diverse costs. As these expenses pile up over the year, you’ll likely find yourself wondering how to decrease the amount of money you’ll owe in taxes.

“For small business owners, filing tax returns can be a painful experience,” warn the tax experts from Forbes. “Often, data is gathered over an evening or a weekend and can be incomplete. Stay organized all year. It winds up saving time and stress. Keep a separate file for taxes, and make sure income and expenses are categorized in the computer or ledger and are accurate. Then, it is just a matter of printing it out.”

Staying organized is a simple concept but requires plenty of effort to put into practice. Set time aside each month to track expenses, review your budget, and make sure you have all necessary documentation related to your small business expenses. While some entrepreneurs eschew technology, this situation is where a reliable software program can save you time, money, and headaches.

The Categories of Your Expenses

Keeping your expenses organized is a required task if you want to categorize them, which is what the IRS requires for any tax deductions.

“Keeping track of business expenses means more than keeping receipts and entering amounts in a ledger,” says a business finance report from the Houston Chronicle. “The Internal Revenue Service asks you to categorize your expenses. This is because some expenses qualify for full deduction, while others may only net a partial deduction. Also, the IRS scrutinizes certain categories to see if they are unusually high. An example of this would be meals and entertainment. Learn to categorize your expenses so you can get the full tax benefits of your deductions.”

Because most small business owners aren’t trained as accountants, it’s important to enlist the help of a professional. This resource will help you navigate the confusing world of tax code, ensuring you get the maximum deduction possible without crossing any legal or ethical boundaries.

There are many different types of business expenses, but here are 9 categories to consider:

1. Professional services: It often takes a village to run a small business. So if you’re paying an accountant, consultant, attorney, or other expert for professional services, those expenses can likely be deducted.
2. Travel: When your travel is directly tied to your business’s benefit, the expenses can often be deducted. For example, this category would include a trip to meet with a client or to attend a trade show. Your accountant may direct you to deduct all expenses related to flights, hotels, car rentals, and meals.
3. Meals and entertainment: Even when you’re not traveling, meals and activities can often be deducted if they’re related to your business. Perhaps you take a potential client out to lunch or reward your employees with a trip to the driving range. With a digital finance tool, you can include notes with the receipt regarding the business purpose. If you’re just keeping hard copies of receipts, write the business purpose on it with a Sharpie so you won’t forget key details later on.
4. Home office: If you operate your business from a designated part of your home, you can deduct a corresponding percentage of your rent or mortgage. You may also be able to deduct a portion of expenses, such as your property taxes, utilities, and HOA fees.
5. Office supplies: Regardless of where your office is, you can deduct expenses related to supplying your office. This category could include anything from computers to chairs to fish tanks.
6. Advertising: Spreading the word about your business can be costly, but those expenses are usually deductible. If you’re investing in something like email marketing, billboards, display ads, or a Super Bowl ad, track your expenses and report them in your tax filing.
7. Vehicles: You have a couple of options available for deducting your vehicle expenses. First, you can use the IRS mileage allowance as a catchall. The other approach is to deduct specific expenses. If you also use the vehicle(s) for personal use, make sure you track those expenses so they don’t bleed into your business-related reporting.
8. Professional development: Getting better at your job and growing within your industry takes effort. You can deduct many of the expenses related to these efforts, such as training seminars and annual dues for industry organizations.
9. Website: Having a website is crucial, so be sure to track the expenses related to design, copywriting, hosting, and maintenance.

No business will ever qualify for every deduction. But that’s not the point. Your goal should be to carefully track every expense so that the tax experience is better. Every positive action you take in January or May will pay dividends the following April as you navigate the tax reporting process quicker and come away with a lighter bill.

The information provided in this post does not, and is not intended to, constitute tax advice; instead, all information, content, and materials available in this post are for general informational purposes only. Readers of this post should contact their tax professional to obtain advice with respect to any particular tax matter.