Tax Blog

Start-Up Small Business – Part 3 – What Can I Expense?

According to the IRS, expenses available for deduction include: A business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.

Even though an expense may be ordinary and necessary, you may not be allowed to deduct the expense in the year you paid or incurred it. In some cases, you may not be allowed to deduct the expense at all. Therefore, it is important to distinguish usual business expenses from expenses that include the following.

  • The expenses used to figure cost of goods sold.

  • Capital expenses.

  • Personal expenses.

What a company spends to acquire assets is not deductible against income. For example, money spent on inventory is not deductible as expense. Only when the inventory is sold, and therefore becomes cost of goods sold or cost of sales, does it reduce income.

Generally companies want to maximize deductions against income as expenses, not assets, because this minimizes the tax burden. With that in mind, seasoned business owners and accountants will always want to account for money spent on development as expenses, not assets. This is generally much better than accounting for this expenditure as buying assets, such as patents or product rights. Assets look better on the books than expenses, but there is rarely any clear and obvious correlation between money spent on re

search and development, and market value of intellectual property. Companies that account for development as generating assets can often end up with vastly overstated assets, and questionable financials statements.

Another common misconception involves expensed equipment. The U.S. Internal Revenue Service allows a limited amount of office equipment purchases to be called expenses, not purchase of assets. You should check with your accountant to find out the current limits of this rule. As a result, expensed equipment is taking advantage of the allowance. After your company has used up the allowance, then additional purchases have to go into assets, not expenses. This treatment also indicates the general preference for expenses over assets, when you have a choice.

Sometimes people want to treat expenses as assets. Ironically, that’s usually a bad idea, for several reasons:

  • Money spent buying assets isn’t tax deductible. Money spent on expenses is deductible.

  • If you capitalized the expense, it appears on your books as an asset. Having useless assets on the accounting books is not a good thing. The costs of getting started in business, before you actually begin business operations, are capital expenses. These costs may include expenses for advertising, travel, or wages for training employees. If you go into business. When you go into business, treat all costs you had to get your business started as capital expenses. Usually, you recover costs for a particular asset through depreciation. Generally, you cannot recover other costs until you sell the business or otherwise go out of business. However, you can choose to amortize certain costs for setting up your business. Capitalizing expenses creates the danger of overstating assets.

  • If you capitalized the expense, it appears on your books as an asset. Having useless assets on the accounting books is not a good thing.

The costs of getting started in business, before you actually begin business operations, are capital expenses. These costs may include expenses for advertising, travel, or wages for training employees.

If you go into business. When you go into business, treat all costs you had to get your business started as capital expenses.

Usually, you recover costs for a particular asset through depreciation. Generally, you cannot recover other costs until you sell the business or otherwise go out of business. However, you can choose to amortize certain costs for setting up your business.

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