What is a business expense?

December 28th, 2010 BY Claire Moore

It sometimes surprises me what small business owners think is an expense. It really gets interesting at tax time when they’re looking for every possible deduction to lower their tax bill.

Expense defined

The short answer is that an expense is the outflow of an asset, usually cash, in order to help the business operate and make a profit. In order for the expense to be deductible on your tax return, the expense must be both ordinary and necessary for your business.

Ordinary and Necessary

While you might think that your child care costs are necessary for your business, the IRS would disagree. Let’s say that you run a little retail flower shop. Child care is not ordinary or necessary for the shop. Typical expenses would include: utilities, rent, office supplies and gas for the delivery vehicle. Your largest expense is your cost of goods sold — the cost of the inventory that went out the door in sales.

How to Handle Assets

Large expenditures for assets, such as equipment, are not expensed all at once. Instead they are capitalized. That is, they are added to your assets and will be expensed over their useful life in a process known as depreciation. In that way you are able to match the cost of the equipment over time with the sales revenue that was generated over time.

Part Business – Part Personal

Some of your expenses are only part business. One prime example is your car. No doubt some of your trips are business related so the costs for these can be expensed against business revenue. To get the deduction you need to keep records of the business usage of your car. I recommend that you keep a log book inside your car. Get into the habit of logging every business trip noting: the date, purpose of the trip, beginning and ending odometer readings. At the end of the year you’ll be able to calculate your total business miles for the year and you can expense them at a rate of 55 cents per mile. This is the easiest way to go and in my experience tends to give you the best deduction. But you have to be good about keeping the records. Don’t wait until the end of the year to try and construct your mileage log. Do it every day and it’s much easier and more accurate.

Other partial expenses may include: telephone, cell phone, and internet connection.

Other deductible business expenses may include: interest, taxes, insurance, payroll and benefits for employees, and advertising costs.

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