Definition of business expenses
Business expenses are costs incurred in the ordinary course of business. They can apply to small entities or large companies. Business expenses are part of the income statement. In the income statement, business expenses are subtracted from income to arrive at the taxable net income of a business. Business expenses can also be called deductions. In general, companies have limitations and special considerations for deductions for business expenses. They are generally divided into capital expenditure and operational expenditure.
Breakdown of business expenses
Section 162 of the Internal Revenue Code (IRC) deals with guidelines for business expenses. IRC allows businesses to report any expenses that may be ordinary and necessary. Business expenses do not have to be considered ordinary or necessary. Generally, ordinary means that expenses are common in the industry and that most business owners in the same industry or trade would potentially spend these things. Necessary means spending helps business, is appropriate, and a business owner may not be able to run the business if they haven’t done the spending.
An expenditure that meets the definition of ordinary and necessary for commercial purposes is liable to expenditure and therefore tax deductible. Some business expenses may be fully deductible while others are only partially deductible (often using form 2106-EZ). Here are some examples of fully deductible eligible expenses:
- Accounting or banking fees
- Membership fees
- Subscriptions to publications
- Marketing and advertising costs
- Education and training costs
- Salaries paid to contract employees
- Employee benefit programs
- Equipment rental
- Insurance costs
- Interest paid
- Laundry charges
- Office expenses and supplies
- Maintenance and repair costs
- Rent on offices
- Public service expenditure
- Printing and copying costs
- Legal fees
- Costs of stages
Declaration of results
The income statement is the main financial statement used by the entities to record their expenses and determine their taxes. Entities will generally have three categories of expenses which are broken down by direct costs, indirect costs and interest on the income statement.
The value of inventory in stock at the beginning and at the end of each taxation year is used to determine the cost of goods sold (COGS), which represents a significant direct expense for many businesses. The COGS is deducted from the total revenue of an entity to find the gross profit for the year. Expenses included in the COGS cannot be deducted again. Expenses included in the COGS calculation can include direct labor costs, plant overhead, storage, product costs and raw material costs.
Indirect costs are subtracted from gross profit to identify operating profit. Indirect costs generally include such things as executive compensation, overhead, depreciation and marketing costs. Subtracting indirect costs from gross profit translates into operating profit, also called profit before interest and taxes.
The expenditure of the assets of the company is generally made by depreciation. Amortization is a tax deductible expense in the income statement which is classified as indirect expense. Depreciation expenses can be deducted over a number of years and include the costs of computers, furniture, goods, equipment, trucks, etc.
Gifts, meals and entertainment
The IRS has several restrictions on several costs, primarily the costs associated with gifts, meals and entertainment. For more information on these and other costs under close monitoring by the IRS, see publication 535, Business Expenses.
The last section of the income statement involves interest and tax expenses. Interest is the last expense a business subtracts to arrive at its taxable income, sometimes called adjusted taxable income.
In some cases, the expenses incurred by a business owner can be both personal and professional. For example, a small business owner can use their car for personal and business purposes. In this case, the portion of miles used for business purposes can be deducted. In the case of home offices, the costs associated with the part of the house that is used exclusively for business are generally deductible.
Certain expenses incurred by a business are not to be declared. These expenses include bribes, lobbying fees, penalties, fines and contributions made to political parties or candidates.