Categorizing expenses isn’t just about prepping for tax season. Proper business expense categorization can prepare you for a future of growth and savvy financial management.
Each and every business expense needs to be documented in a way that allows you to quickly assess your finances and liquidity level and maximize tax deductions.
Even if you’re a business owner who believes your business isn’t large or complicated enough for developing a documentation process, we recommend starting with some simple categories that will benefit purchasing, budgeting, and your yearly tax write-offs.
What are business expense categories?
Business expense categories are “buckets” for your company’s spending that help you organize your finances. They’re essential for several reasons, including:
- Showing you where your money is going
- Defining budgets for your department heads
- Highlighting places where you could be more efficient
- Helping you prepare for tax season
Most of your expenses will fall into the same main categories, but it’s worth taking the time to customize your chart of accounts. Creating enough categories to label every transaction and source of income—no matter how rare—can provide helpful insight into your business spending.
Essential business expense categories
Expense categorization needs to be straightforward so everyone from employees recording business expenses to the finance team utilizing accounting software knows exactly where money is going.
Using expense management software like BILL Spend & Expense lets you share the burden of categorization with employees, so your accountants don’t have to waste their time chasing down spenders.
Common business expense categories include:
Payroll
For most businesses, payroll constitutes the largest share of the budget. Create a payroll expense category to easily identify and filter out the fixed expense of payroll, and help you track trends in the variable cost of hourly, fluctuating payroll wages. Learn how to set a pay schedule that works best for your business.
Employee benefits
Employee benefits include all of the non-wage perks offered to employees.
The employee benefit programs you offer will be different from other companies, and the offerings may change over time. Still, it’s critical to note all of the costs related to these programs so you can track your spending over time and see which give your employees the highest return on investment.
Common benefits include:
Insurance
This covers all business expense categories related to employee benefit insurance programs, including health insurance, dental, vision, life, disability.
In compliance with state laws, businesses must pay workers’ compensation insurance, which pays for the wages and healthcare of employees who are injured or sick due to work activity.
Vacation days
Some business expense categories aren't expenses in and of themselves, but it's important to capture the costs of administering these programs.
Sick days
Like vacation days, sick days don't represent a direct tax deductible business expense, but costs associated with administering the benefits, such as software or contracted professional services, can still reduce your taxable income.
Child care
This includes any fees paid to cover child care benefits for your employees.
Gym or fitness allowances
Are gym and fitness allowances tax deductible business expense categories? They can be—if you have a formal, written policy for this benefit and your employees offer appropriate documentation for the expenses.
Retirement
Be sure to include contributions you make to your employees' retirement plans as well as the costs of administering the plan, such as the software you use for your HR business operations.
Education and training
Remember, the IRS defines business expenses as those that are ordinary and necessary to your business. Training your employees counts as a deductible expense.
Subscriptions or memberships
Be sure to define the kinds of subscriptions and memberships you're willing to reimburse. As long as they're well defined for business purposes, these usual business expenses can be tax deductible.
This is not an exhaustive list, so be sure to properly categorize any business expenses designed solely for rewarding, attracting, and benefiting employees.
Rent and utilities
The overhead costs of your business are critical to keep the lights on—literally.
These expenses can be fixed or variable costs, but they are necessary to run your business. Tracking these over time can help you notice trends or cost creep, as well as deductions come tax time.
Most rent and utilities can be tax-deductible if deemed “ordinary & necessary” by the IRS.
This category might include:
- Rent or mortgage payments for your office space
- Electricity
- Gas
- Sewage
- Trash collection
- Internet
- Phone
Business insurance
Does your business carry property insurance or liability insurance? Don't forget these business expense categories at tax time. Fees paid for business insurance can reduce your taxable income.
Bank fees
Every dime counts. Hopefully your business isn't paying exorbitant bank fees, but when you do have to pay them, at least they're tax-deductible.
Marketing and advertising
Create a category solely for the marketing and growth of your business. Be sure to track any expenses related to advertising, whether it’s radio, print, internet, mail, or television.
If your business uses social media, email, visual display, or paid click marketing it would fall in this category as well.
Expand the umbrella to include any additional production costs, such as hiring a video crew to produce a commercial.
Office supplies
No matter the type of workplace, you’ll likely need to purchase items regularly for day-to-day productivity. These are considered office expenses.
Office supplies could include paper products, kitchen supplies, and even snacks and drinks.
Business meals and entertainment
Your company’s meal and entertainment expenses are the most likely to be abused and least likely to be reported correctly. Still, these expenses may be tax-deductible and will be the first place to cut when you’re in a tight spot, so categorizing these expenses correctly is vital.
This category would include meals provided to employees, such as a team lunch or the annual company Thanksgiving dinner before the holiday, as well as meals for clients when the sales team is courting a new account.
An entertainment expense usually covers large events, such as a company party or taking clients to a sporting event.
Filing a meal expense report is notoriously tedious. Meal receipts are easily lost before an expense report is even filed, so consider your expense reporting process and make the switch to digital expense reporting software if possible.
Actively managing, categorizing, and budgeting for the meals & entertainment expenses in your company can keep purchases in check.
Business travel
A travel expense is incurred whenever business takes place outside of your normal workplace. It could include flights, lodging, food on the road, cabs or car rentals, and mileage reimbursement.
The T&E expense category will be dependent on the standard mileage rate for computing reimbursements and mileage deductions.
You’ll want to consider all different types of travel expenses, from travel arrangements made by your travel or accounting teams down to the out-of-pocket expenses your employees submit after their business trip.
Business vehicles
For many businesses, vehicles are part of the day-to-day operations and can contribute expenses in a significant way. From cars to trucks to specialized vehicles for your industry, your rental or loan payments on these vehicles and any other costs associated with them need to be classified and tracked.
In this category you’ll find traditional costs associated with normal car expenses:
- Lease or loan payments and interest
- Registration fees and taxes
- Insurance
- Gas
- Maintenance and repairs
- Parking fees, tolls, and storage
There are two different methods of recording vehicle costs: the actual expense and standard mileage method. Choose and stick to one of the methods in your expense categorization process.
Depreciation and amortization
Depreciation and amortization are a unique business expense category as they don’t represent money changing hands. So what exactly are they?
Large scale purchases are often capitalized. What this means is that they are recorded as an asset on the balance sheet as opposed to the income statement with the costs being spread out over the useful life of the item.
Capitalizing applies to large scale with a use that goes beyond the year like machinery, vehicles, trademarks, and patents.
These expenses are tax deductible, even if there isn’t money changing hands. With amortization and depreciation, you spread the tax deductions over each year you are depreciating or amortizing the asset over. If you’re unfamiliar with these practices, talk to an accountant or finance professional to make sure it’s being recorded properly.
Additional services
It makes much more economic sense to contract out some responsibilities to dedicated professionals. Instead of adding a full-time accountant or lawyer on retainer to your payroll, you may pay project fees or contract rates to these professionals as needed.
Services that can be outsourced might include:
Accountants and tax preparation
Whether you pay your accountant a monthly fee or you just pay someone to do your taxes at the end of the year, that's a tax-deductible business expense.
Collection fees
Paying a service to help you attempt to collect overdue customer payments or other types of collections are generally deductible.
Landscaping and cleaning
Whether you contract a single individual or a large professional service, these common office expenses are tax-deductible.
Lawyers
Paying a lawyer to help you organize your business and file the right paperwork in your state is an ordinary and necessary business expense, as are the costs related to filing the paperwork.
Marketing and media production
Do you outsource your marketing services? Your advertising costs are tax deductible as well as what you pay to the marketing agencies that create your ads and manage your advertising placements for you.
Security
Do you pay a security service to keep an eye on your property either during or after business hours? These professional services count as tax-deductible business expense categories.
Software subscriptions
The software involved in operations are becoming one of the most common business categories. But it’s also an expense category that can become bloated if you’re not routinely reviewing how valuable the software is to the business.
From trials that never get cancelled to subscriptions that aren’t being used, precious dollars can be routinely sunk into unused software licenses.
It’s also essential to compare subscription costs against competitors. There may be a more cost-effective option on the market that provides the same value to the business.
Startup costs
There are unique costs at the onset of a business belong in their own category. This includes market research, business development, and other related expenses that pertain to building the business before launch.
Maintenance and repairs
Throughout the course of operations, your real estate, equipment, facilities, and vehicles will incur some wear and tear. Any maintenance or repairs belong in their own expense category.
Business insurance
Generally speaking, business insurance premiums are tax deductible expenses. For an insurance policy to be considered a business expense, it must be paid through the business and be considered both ordinary and necessary expenses.
The most common types of business insurance expenses are:
- Property insurance for any owned commercial real estate
- Professional liability insurance to protect against claims of negligence
- Product liability insurance for instances of damages due to defects or manufacturing errors
- Commercial auto insurance that covers any business vehicles
- Business interruption insurance that covers lost revenue in the case of a disruption such as a natural disaster
- General liability insurance which covers claims of injuries or damage caused by business operations
Personal insurance premiums such as life insurance are not considered business expenses and should not be included in your business expense list.
Bank fees and interest
It’s best practice to have a separate business bank account and a business only credit card to keep your business transactions separate from anything personal. As an added benefit, any bank fees, account maintenance fees, overdraft fees, application fees, and interest paid can be tracked as a tax deductible business expense.
This also applies to third party payment processors and digital wallets like PayPal. The transaction fees paid are similarly applicable as a business expense.
Business loan, line of credit, and mortgage interest
It’s common for businesses to turn to lending for the capital they need to grow and accomplish their goals. If you’re one of those businesses, the interest you pay on the owed amount is tax deductible.
Payments are typically taken out as one amount with a portion going towards the owed balance with the rest being an interest expense. The loan, line of credit, or mortgage provider should provide both an amortization schedule and monthly statements which break out the payments into both amounts.
For the interest portion of a business loan, line of credit, or mortgage to be tax deductible, the liability must be in the business’s name.
List of business expenses
To get you started, here are a few examples of business expense categories that many businesses include in their accounting structure.
Be sure to check with your accountant when it comes to your own list so you don’t miss any tax deductions.
What is not considered a business expense?
While you’re sorting and labeling your expenses, it’s important to distinguish between business and non-business expenses. Not only is this critical for reimbursements and tax deductions, but it’s a way to keep your spending in check and prevent occupational fraud.
Personal vs. business expenses
For small businesses, it’s common for the business owner to have considerable overlap between their business and personal finances. Vehicles might be used for both business and personal reasons, and so can a home.
Breaking up the cost by percentage of use can help you more accurately categorize only the business portion of the expense. For example, tracking the miles you drive specifically for your business or the amount of space in a home dedicated to business operations can help you itemize for deductible business expenses.
Business loans and loan payments
The payments you make on your business loans are not generally tax-deductible expense categories. However, the interest you pay on those loans can be.
So be sure to capture the principal and the interest you pay on your loans as separate expense categories.
How do businesses categorize expenses?
Expense categorization is simple at face value, but can become complicated as you dig in.
The first step in accurately categorizing business expenses is understanding the unique aspects of your business. How you categorize business expenses should reflect how you understand your business.
What are your costs of fulfillment? What are your operational costs? Do you want to see your costs by department? By product? By service?
Once all of these considerations are taken into account, you’ll start to understand how to break down your expense categories to reflect that. While there is some standardization that’s required (per Generally Acceptable Accounting Principles), you have leeway to customize your accounts to serve your needs.
Your process or books may not be the same as other businesses in the industry. What’s important is that, if they differ, it’s to serve a purpose.
Tax deductible business expenses
The practice of categorizing your expenses comes in particularly handy when tax season arrives. The IRS allows businesses to deduct costs incurred throughout the year which are ordinary and necessary to the business.
As you can imagine, your small business expenses are largely ordinary and necessary for your industry, so the amount of your deductible expenses is quite high.
Seven of the most common deductible business expenses are:
- Mileage and vehicle expenses
- Entertainment expenses
- Rent and utilities
- Marketing expenses
- Employee pay and benefits
- Gifts
- Miscellaneous or general office expenses
Categorizing your expenses allows you to quickly itemize these lists and provide totals that you need for filing at the conclusion of your tax year and claiming every tax deduction to which you’re entitled. Maximizing your tax return is well worth the effort.
Best practices for expense categorization
Expense categorization doesn’t need to be a pain point in your operations. Build off of these best practices, and you’ll keep your expenses organized with ease:
- Set your standards early on: Consistency is key in expense categorization. The earlier that you set the standards to your expense categorization, the easier it will be to stick to them.
- Understand your business’s needs: Every business has different needs when it comes to expense categorization. Build out expense categories that reflect your complexity and needs, broken down in a way that’s relevant to your operations.
- Keep consistent with your practices: Once the standard is set, stick to it. Regularly devote time to categorizing, auditing, and reviewing expense categories. If you feel you need to change the standards, wait until the start of a new accounting period.
Think about what you want to get from expense categorization. Remember that if you want simple expense categorization, you have the leeway to do so. And if you have complex needs, build a system that sustains it efficiently.
Categorizing with expense management software
All of these categories and tax talk can be intimidating, but using expense management software can make categorization easy and intuitive.
Expense management software helps in the following ways:
- Tracking expenses
- Managing budgets
- Importing information from expense reports, bank accounts, etc. automatically
- One click or suggested categorizations
- Easy sorting by category, date, amount, or user
- Visual interpretation of spend and budgets
