If you are a business owner, you will inevitably incur a variety of business expenses over the course of running your business. Most companies are eligible for tax deductions - expenses that can be written off to optimise a business's tax situation.
Unfortunately, many business expenses cannot be claimed as tax deductions, so in order to maintain accurate financial records and steer clear of fines and penalties, it is essential for businesses to know which costs are deductible and which are not.
Deductible vs. Non-Deductible Expenses
Deductible business expenses are those that can be subtracted from your business revenue when you file for taxes, in order to calculate your total amount of taxable income. The Internal Revenue Service (IRS) defines allowable business deductions as expenses that are both ordinary and necessary. Ordinary costs are expenses that are common and widely accepted in your industry, frequently incurred by owners in the same line of business. Necessary expenses are costs that are helpful and appropriate for your business, including those that a business owner may not be able to manage without.
Many operating expenses qualify as deductible, including rent or lease payments, utility bills, office supplies, devices used for business purposes - such as computers - and salary expenses. Costs incurred through advertising and marketing, traveling for work assignments, and employee training programs are all classified as deductible expenses.
Non-deductible expenses cannot be deducted from your business revenue before it's assessed for tax; these are the expenses that do not meet the IRS's criteria for ordinary or necessary and those that are not directly tied to running your business or producing income. While the criteria appears to be simple enough, the classification becomes a little less black and white when certain expenses cannot be written off, even though they might serve business purposes - so it is important to know the difference.
Common Examples of Non-Deductible Expenses
1. Personal Expenses
Any expense that lacks a primary business purpose cannot be written off. Logically then, personal and family expenses, including vehicles, mobile phones, personal groceries and clothing (unless it's safety gear or a branded uniform), epitomize non-deductible costs.
In some cases, personal and business expenses might overlap. For example, if you use a mobile phone for both personal and business use, you'll need to make a plan to split the bills, paying a portion from your personal account and the other from your business one. If you operate your business from home, you cannot deduct expenses relating to any part of your home used for both business and personal purposes; if you have an office space containing devices and supplies that are also used by the whole family, they will not qualify as a tax-write off.
This is why it's a good idea to clearly separate personal and business expenses, buying separate items for family use and business operations wherever possible.
2. Commuting
Whether you use public transport, a personal vehicle, or any other travel means, commuting costs are generally non-deductible. The IRS does not classify expenses covering travel from your home to your place of work as deductible, but traveling to work and client meetings and between business destinations throughout the workday is.
3. Entertainment
After the 2017 Tax Cuts and Job Act was passed, business owners could no longer write off entertainment expenses; prior to 2018, up to 50% of certain entertainment costs could be deducted. Costs can no longer be deducted for entertaining clients, and these include tickets to theater performances, concerts and sports events.
4. Some Meals
Daily lunches cannot be written off unless you are away from your usual workplace or office. Most of the time, employers can deduct 50% off business meals if they meet certain conditions, including the presence of the business owner and involvement of business contacts only (employees, clients, or consultants). The meal must also have an ordinary or necessary business purpose and must not be lavish or extravagant.
5. Political Contributions
Many businesses make donations to political candidates or campaigns they believe would benefit their industry. However, political contributions do not qualify as deductible expenses, even if you're lobbying for a cause that would help your business and appear to be a business investment.
6. Charitable Contributions
Charitable donations may be deductible, but it depends on the structure of your business. If your business is classified as a C corporation, charitable contributions may be deducted up to 25% of your taxable income. For S corps, self-employed individuals, sole proprietors and partnerships, charitable contributions can be claimed on personal tax returns, but do not qualify as deductible business expenses.
7. Gifts over $25
It's common for businesses to show appreciation for their employees, customers or clients with gifts that come in many forms - cash, a box of chocolates, a gift card, or flowers. However, the limit is $25 per recipient per year; anything you spend beyond this amount is a non-allowable deduction. In addition, any gift that could be considered entertainment, such as a movie, concert or sporting event ticket, does not qualify and cannot be written off.
Other Non-Deductible Expenses
Other non-deductible business expenses include fines and penalties, some insurance premiums, and capital expenditure. If you are unsure of the classification of any given expense, it's always a good idea to talk to a professional and gain an understanding of the nuances.
The Importance of Tracking All Expenses
Even though non-deductible expenses cannot be subtracted from a company's taxable income, it is important to keep a clear record of all expenses. Accurate record-keeping ensures compliance with legal requirements and is essential in the event of a financial review. Misclassifying expenses can lead to serious repercussions, including an IRS audit, a legal investigation, or a penalty.
Moreover, keeping track of all your expenses provides a complete picture of your business's financial health, allowing you to analyze spending patterns and gain insight into any areas where costs can be managed more effectively. If you do not record all of your expenses, your financial goals remain theoretical and will be more difficult to attain.
Proof of Expenses
The IRS no longer requires businesses to keep all hard-copy expenses, but it does mandate that all documentation meets record-keeping standards. An electronic receipt - in the form of a scanned copy or digital image - must be clear and legible, and must be considered a valid proof of purchase.
As much as possible, businesses should collect itemized receipts, which include a list of each product and its specific price, the date, vendor information, taxes and fees, the grand total, and other details pertaining to the transaction. This is especially important when reimbursing your employees for any payments they make; if the receipts submitted are non-itemized, you have no way of discerning whether the expense is tax-deductible or not. With itemized receipts, you mitigate the risk of writing off any expenses that actually cannot be claimed, and so avoid the potentially serious repercussions of making a tax error.
It's necessary to have a comprehensive plan for collecting and organizing all your receipts, invoices, bills and other expense documents. There are a host of receipt scanning apps available today, which are able to digitally store and categorize receipts. Eliminating the need for multiple tools, many business expense software platforms have the ability to scan and upload receipts, while tracking your business's spending and generating reports.
Strategies for Tracking Expenses
Establishing an internal process for tracking your expenses is key for efficient record-keeping, and business expense tracking software enables the seamless tracking of your expenses and reporting. To help businesses separate expense categories, many platforms have a built-in option to mark an expense as non-deductible; if not, you may need to set up distinct categories for expenses of this type. Managers can also set expense rules within the software to establish whether an expense is considered non-deductible.
Many business expense tracking tools - including Ramp and Zoho Expense - can be integrated with accounting software to streamline financial reporting. Ideally, you also need to have a business bank account (separate from your personal account) that has the ability to integrate with accounting software. This will allow you to compare expense documents with card transactions.
Consulting with a tax professional can be highly beneficial for your business, in tandem with the use of accounting software. Since professionals have expert knowledge on tax laws - which can be complex - they can help your business ensure compliance, prevent the mischaracterization of expenses, and maximize deductions.
Conclusion
Learning how to navigate the rocky terrain of non-deductible expenses can present its challenges. If you want to save on taxes, monitor your business performance, and boost your organization's financial health, the first step is to get clear on which expenses qualify as allowable deductions and which do not. The implementation of integrative software will allow you to seamlessly categorize and track your expenses, ensuring that you avoid unnecessary risks while being able to manage budgeting and forecasting more effectively .
