The Internal Revenue Service (IRS) considers an expense to be deductible if it is both “ordinary and necessary.” Similarly, if you operate in Canada, the Canada Revenue Agency (CRA) considers a business expense as a, “cost you incur for the sole purpose of earning business income.”
These definitions can be confusing and often small business owners misinterpret their allowable business expenses. In this article, we’ll provide some simple guidelines that you can follow to see what qualifies as a business vs a personal expense.
Please note that total deductions will vary depending on a variety of factors including your business structure, where you operate and the industry of your business. For more details on business expense deductions, please contact your local tax authority and/or accountant.
Purpose of the Expense
If the expense is related to the operation or maintenance of the business, it is considered a business expense. For example, supplies, rent, utilities, and equipment are business expenses. On the other hand, expenses that are not related to the business, such as groceries, clothing, and personal travel, are considered personal expenses.
Use of the Expense
If the expense is used for both personal and business purposes, the business owner can allocate the expense based on the percentage of business use. For example, if a vehicle is used 50% for business and 50% for personal use, the business can deduct 50% of the expenses related to the vehicle.
However, this can be way more confusing than it is helpful, especially if you try to expense a percentage of your rent as a home office (it’s possible!). That is why we always recommend keeping your business and personal expenses separate.
Industry Standards
Some industries have established standards for what is considered a business expense. For example, in the consulting industry, travel and entertainment expenses may be considered business expenses if they are related to client meetings or business development activities.
Another example is for contracting services, you can expense the gas/mileage it takes to go from site to site as well as any fuel used to get emergency supplies. You can’t, however, expense the gas you use to go drive to lunch.
Maintain Proper Documentation
In order to claim a business expense, you will need to keep proper documentation for all expenses, this includes receipts and invoices.Through proper documentation, small business owners like yourself can prove to tax authorities that your expenses are legitimate and are necessary for your business. It also saves a lot of time and headaches during the tax season!
For the most part, business expenses typically fall into these main categories:
Advertising and marketing expenses
Vehicle expenses: fuel, maintenance depreciation
Business insurance
Supplies and equipment
Employee salaries, wages, and benefits
Legal and professional fees
Rent or lease of business property
Repairs and maintenance of business property
Telecommunications expenses:internet and phone services
Travel expenses: airfare, hotels, and meals
*Please consult your local tax authority and/or accountant for details on typical expense categories for your particular business.
Wrapping it up
By using these guidelines, small business owners can determine what is a business expense and what is a personal expense. It is important to keep accurate records of all expenses to take advantage of tax benefits, save you time and most importantly earn your business the most money possible.
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