Whether you own an established business or a startup, it is essential to have your expenses adequately documented so that you (or your bookkeeper) are prepared at tax time. Do you know which expenses you should track? The answer, in short, is all of them.
Understanding the tax deductions available to you is an integral part of your business. The deductions you may be eligible for are primarily determined by your business classification with the IRS. If you work with a professional bookkeeper, CPA or financial advisor, they’ve likely advised you to keep receipts from transactions for items such as meals, gas, or travel. They’ve probably also advised you on what expenses are considered fully deductible, partially deductible and never deductible.
What Can I Deduct?
While differentiating between personal expenses and business expenses might seem like common knowledge, you would be amazed at how many business owners commingle their funds. Business expenses are defined as “the costs of carrying on a trade or business…usually deductible if the business operates for a profit.” As a business owner or operator, it’s important to understand when to classify an expense as business or personal. Let’s define personal expenses versus business expenses.
Personal Expenses
Personal expenses that are tax deductible include:
- Mortgage interest
- State and local taxes (up to $10,000)
- Medical expenses and health savings accounts
- Charitable donations
- Traditional IRA (Not Roth)
- Education expenses
- Student loan interest (up to $2500)
Business Expenses
Business expenses are divided into three categories: fully deductible, partially deductible and never negotiable.
Fully Deductible Business Expenses include:
Advertising, marketing, and promotional costs
Labor
- Fees, dues, and subscriptions
- Office equipment and supplies
- Benefits, training or continuing education
- Insurance like renter’s, property or casualty, life or disability (for partnerships)
- Utilities, rent and Internet/phone
Partially Deductible Business Expenses include:
- Gifts
- Home office deductions (work-from-home positions)
- Automobile mileage
- Travel
Never Deductible Business Expenses include:
- Business clothes (unless it’s a uniform)
- Commute costs to your place of business
- Meals and entertainment
- Political donations
- Fines or penalties
- Life insurance premiums
Reviewing Your Transactions
Once you are clear on how to classify your expenses, it will be easier to distinguish when to use your business account versus when to use your personal account. If you look through your expenses from the past and realize that you were commingling funds, stay calm. This isn’t uncommon, but it is a huge no-no, and one of the most common ways businesses find themselves getting audited by the IRS. If you make this discovery, the next step is to schedule an appointment with a bookkeeper or accountant who can help you sort through any challenges.
When you make an appointment with your bookkeeper or accountant, be sure to print a copy of your most recent transactions and review each line item with him or her. In the end, this person will help you uncover personal and business expenses, but it is up to you to make sure you are also reviewing the account for any commingled funds so that you do not repeat the mistake.
Deducting Business Expenses
Now that you have a better understanding of business versus personal expenses, you are in a stronger position to work closely with a financial professional. As professional advisors to our clients, we always share new information about changes to how the IRS defines business expenses—here’s a helpful IRS resource just in case you want to keep up with these changes on your own: IRS Deducting Business Expenses.
About Lisa Palazzo
Lisa Palazzo is the Owner and CEO of Palazzo & Company, an tax and accounting firm based in Gulfport, Mississippi. Lisa Palazzo specializes in EXPAT taxes (knowledge earned first-hand from starting her business while working overseas) and working with small businesses. With clients in more than 20 countries, Palazzo has grown since 2001 to become a worldwide service provider specializing in small business accounting, bookkeeping and payroll services, business income tax preparation, and local/individual income tax preparation.