What Are Considered Expenses for Businesses and Tax Purposes?

Businesses incur various costs to keep operations running, and understanding which qualify as expenses is essential for financial planning and tax reporting. Proper classification ensures accurate accounting records and helps businesses take advantage of tax deductions.

Expenses can be categorized based on their purpose. Some are tied to daily operations, while others involve long-term investments or reimbursements. Clear documentation is necessary to comply with tax regulations and maintain financial transparency.

Operating Costs

A company’s routine expenses fall into different categories based on their function. These costs sustain daily operations and ensure efficiency. Some relate to producing goods or services, while others focus on sales or administration.

Production-Related

These costs are directly tied to making a product or delivering a service. For manufacturers, this includes raw materials, factory wages, and utility expenses for production facilities. A bakery’s flour, eggs, and sugar are production-related costs, as are bakers’ wages and oven electricity. In service-based businesses, software subscriptions for graphic designers or fuel for delivery companies fall into this category.

Production-related costs are classified as direct or indirect. Direct costs can be traced to a specific product or service, such as raw materials or assembly labor. Indirect costs, or overhead expenses, support production but are not tied to a single product, like factory rent or machine maintenance. This distinction is important for calculating the cost of goods sold (COGS), which affects profitability and tax reporting.

Selling

These expenses cover promoting and distributing products or services. Advertising, sales commissions, and marketing costs fall into this category. Spending on online ads, billboards, or direct mail campaigns qualifies as selling expenses.

Employee wages for sales representatives and their travel costs for client meetings are included. Maintaining an e-commerce platform or running a customer service team also falls under selling expenses. Businesses with retail locations may include store display setup and promotional materials.

Selling costs are generally deductible in the year they are incurred if they are ordinary and necessary. The IRS defines “ordinary” as common in a particular industry and “necessary” as helpful for business operations. Proper tracking ensures businesses claim the appropriate deductions and reduce taxable income.

Administrative

These expenses support the business but are not tied directly to production or sales. Examples include office rent, administrative salaries, insurance premiums, and accounting or legal fees. Internet and phone bills, office supplies, and business software subscriptions also fall into this category.

Unlike selling or production costs, administrative expenses do not fluctuate based on sales volume. Whether a company sells more or fewer products, it still pays for office space, IT support, and compliance-related services. Some costs, like professional consulting fees, may vary over time.

Administrative expenses are generally deductible unless they involve non-business activities. Office rent is deductible, but a personal home office is only deductible under specific conditions. Proper classification prevents misreporting, which can lead to penalties or audits.

Capital Purchases

Businesses invest in long-term assets that provide value over multiple years rather than being consumed in daily operations. These expenditures include property, equipment, and technology investments. Unlike routine expenses, they are not immediately deducted from taxable income but are capitalized and depreciated over time.

The IRS requires businesses to follow depreciation schedules under the Modified Accelerated Cost Recovery System (MACRS). Depreciation periods vary by asset type—office furniture is typically depreciated over seven years, while commercial buildings follow a 39-year schedule. Businesses may deduct a larger portion of the cost upfront using Section 179 expensing or bonus depreciation. For 2024, Section 179 allows up to $1.22 million in immediate deductions for eligible purchases, with a phase-out beginning at $3.05 million. Bonus depreciation permits businesses to write off 60% of the cost in the first year, down from the 100% rate in prior years.

Real estate purchases, including land and buildings, are treated differently for tax purposes. Structures can be depreciated, but land itself is not since it does not lose value. Improvements to real property, such as installing a new HVAC system or upgrading electrical wiring, may qualify for depreciation under the Qualified Improvement Property (QIP) category, which follows a 15-year recovery period.

Vehicles used for business purposes are capital assets, though tax treatment depends on ownership structure and usage. A company purchasing a fleet of delivery trucks depreciates them over five years under MACRS rules. Passenger vehicles are subject to annual depreciation limits set by the IRS. For 2024, the maximum first-year depreciation deduction for a business car is $20,400 if bonus depreciation is applied, with lower limits in subsequent years.

Reimbursable Items

Employees and business owners often pay for work-related expenses out of pocket, expecting reimbursement. These costs must be directly related to business activities and properly documented. Companies establish reimbursement policies detailing covered expenses, reporting procedures, and submission deadlines.

Business travel is a common reimbursable expense. Employees attending conferences, visiting clients, or conducting fieldwork incur costs for airfare, lodging, meals, and transportation. The IRS allows businesses to deduct these expenses if they are “ordinary and necessary,” but reimbursement policies must align with federal guidelines. Per diem rates, set annually by the General Services Administration (GSA), provide standardized daily allowances for meals and lodging, reducing the need for detailed receipts. For 2024, the standard per diem rate for meals is $59, with higher rates in major metropolitan areas. Businesses can reimburse actual expenses instead, but this requires employees to keep detailed records.

Office-related expenditures are another reimbursable category, particularly for remote employees needing supplies or equipment. A company may cover ergonomic chairs, additional monitors, or upgraded internet plans if necessary for productivity. Some businesses offer stipends instead of reimbursements, providing a fixed monthly amount for remote work expenses. Stipends simplify administration but may be considered taxable income if not structured properly. To avoid this, reimbursements should follow an “accountable plan,” meaning they have a clear business purpose, require substantiation, and mandate repayment of excess amounts.

Client entertainment and business meals are also reimbursable, though tax treatment varies. Meals with clients, prospects, or industry partners are generally 50% deductible if they serve a clear business purpose. Internal meals for employee meetings or training sessions follow the same rule unless they qualify as de minimis fringe benefits, such as occasional snacks or coffee. Entertainment expenses, including tickets to sporting events or concerts, are no longer deductible under the Tax Cuts and Jobs Act (TCJA) of 2017, but businesses can still reimburse employees for these costs if they align with company policies.

Non-Business Items

Not all expenditures qualify as legitimate business expenses. Misclassifying personal or non-deductible costs can lead to tax penalties, financial misstatements, or legal consequences. The IRS and financial regulators impose strict guidelines to differentiate between allowable business deductions and personal spending.

Personal expenses mistakenly recorded as business costs are a frequent issue, particularly for sole proprietors and small business owners who intermingle business and personal finances. A common example is a company owner claiming meals, vacations, or personal vehicle expenses as business-related when there is no direct connection to company activities. The IRS scrutinizes such claims under the Internal Revenue Code, which requires expenses to be both “ordinary” and “necessary” for business operations. Improper deductions can trigger audits, penalties, or additional tax liabilities.

Certain payments, even when made through a business account, do not qualify as deductible expenses. Political contributions, lobbying costs, and government-imposed fines fall into this category. Businesses cannot deduct federal income taxes, though state and local taxes may be deductible depending on the entity structure. Similarly, expenses related to securing tax-exempt income, such as legal fees for structuring municipal bond investments, must be excluded from deductions.

Documentation for Tracking

Maintaining accurate records of business expenses is necessary for financial management, tax compliance, and potential audits. Proper documentation ensures deductions are substantiated, reimbursements are justified, and financial statements reflect true business activity. The IRS requires businesses to keep records showing the amount, date, and purpose of each expense.

Receipts, invoices, and bank statements serve as primary documentation. For expenses exceeding $75, the IRS generally requires a receipt with the vendor name, transaction date, and amount. Digital recordkeeping systems like QuickBooks or Expensify help businesses organize and store receipts electronically. Credit card statements alone are not sufficient proof unless accompanied by detailed receipts.

Businesses must also retain mileage logs for vehicle-related deductions, payroll records for employee compensation, and contracts for large expenditures. The IRS recommends keeping financial records for at least three years, though documents related to property purchases or tax filings with potential fraud implications should be retained indefinitely. Well-organized records expedite audits and reduce the likelihood of additional tax assessments.