Expense reporting is an important part of the small business accounting process. The chances are good that not all of the revenue you bring in is pure profit—at least a small portion likely goes towards ensuring you’re able to operate and provide your goods and services to customers.
That said, expense reporting can also be a confusing aspect of business for self-employed people. To help simplify it, we'll break down the self-employed expense reporting process and help you develop a system of your own.
Having a clearly defined process for tracking your expenses is essential for several reasons:
At tax time, you don’t want to have to stress about combing through accounts and classifying purchases. Keeping up with this throughout the year makes tax season much simpler.
An accurate list of expenses enables you to claim more deductions, thus reducing your tax burden and likely keeping a large amount of money in your pocket.
Accurate records help reduce the likelihood of an IRS audit. They also ensure that in the event you are audited, you can easily produce the necessary documentation.
Additionally, tracking your expenses in one place helps give a clearer picture of your business’s actual profits. For this reason, it’s important even if you’re a sole proprietor. When all your business transactions are funneling into a single account, and you’re not tracking, classifying, or differentiating the different types of transitions, it becomes challenging to know just how much money you’re making.
As you might expect, there are some requirements that the IRS has in place for expense reporting. These are generally pretty straightforward (though not always). Additionally, we highly recommend that you develop a consistent system for handling your expenses, as this will make your life as a business owner much easier.
First of all, the IRS has requirements for expense reporting that you need to follow. And, predictably, they can be a little complex. The good news is that a lot of that complexity lies in specific circumstances that the average business won’t run into. That means that by following a few basic guidelines, you can stay compliant.
The main thing to remember is to keep every single receipt. Paper receipts can be filed or scanned and digitized. Many accounting applications also let you attach your receipts to the entry—this is a smart idea. Digital receipts that come in the form of emails should be kept in their own folder or label for easy retrieval.
The other main compliance recommendation is to make sure your expense categories match those used by the IRS. This helps cut down on confusion when you go to file your taxes since you know everything is already in the appropriate category.
Most of these are pretty obvious. Where conflict may arise is when something can fit in more than one category. Here, you’ll want to make sure you defer to the IRS classification to avoid issues.
Here are some of the more common categories:
Car and truck expenses
Commissions and fees
Repairs and maintenance
Travel and meals
Beyond following the guidelines laid out by the IRS, you’ll want to have a system in place for your business to make this process easier. Having a well-defined process ensures that you always record all the details you need and that every entry is handled the same way. It also makes it easier to stay compliant, because you don’t need to do a lot of thinking—you can simply record your expenses and move on to more important tasks.
With the requirements out of the way, the next question you may have is, “What counts as a business expense?”
Let’s start by revisiting the list above:
Advertising. Any costs associated with marketing your business are usually deductible. This includes things like SEO, social media marketing, email marketing software, paid advertising costs (such as Google ads), and other similar marketing expenses.
Car and truck expenses. Costs associated with any vehicles used in your business. Note that if you also use the vehicle for personal use, you’ll need to determine the percentage of use that pertains to the business. Only this portion will be deductible.
Commissions and fees. Commissions and fees involved in operating your business are usually considered tax-deductible expenses. This includes bank fees, professional service fees, and other similar costs.
Contract labor. Fees for any contracted workers are considered deductible business expenses. For example, if you hire a consultant to review your website copy, you can expense the cost.
Insurance. Medical, liability, or property insurance costs are typically considered deductible by the IRS. This also includes insurance policies on specific pieces of equipment, like computers.
Mortgage, rent, or lease. Costs associated with the properties your business operates from are deductible expenses. This includes office space, storage units, and similar costs. Note that if you work out of a home office, you can only deduct a percentage of your mortgage based on the size of your office space. For example, if your office is 15% of the home’s square footage, you can expense 15% of your mortgage.
Office expenses. Office supplies that are used for your business can be expensed. These include paper, pens, file cabinets, printer ink, and the like. You can also deduct larger items such as office furniture.
Repairs and maintenance. Repairs and maintenance on both your office spaces and on business equipment count as valid expenses. You can generally deduct the full amount of these repairs. The main exception here is, again, with home offices: you can only deduct repairs and maintenance if they’re done on your home office space specifically (or another area where business is conducted). Let’s say you paint your kitchen. If you have discussions with clients in your kitchen, you can deduct that expense. If you never have clients in your home and only work in your office, you can’t deduct the kitchen-related expenses.
Travel and meals. Travel expenses are deductible. This includes gas and mileage, air travel, and the like. You can deduct 50% of the cost of business meals. General entertainment expenses are no longer deductible.
Utilities. Utilities like electricity, sewer, garbage, phone service, and internet access are deductible expenses. This includes utilities at home if you use your home as an office. However, you’ll only be able to deduct a portion of those utilities based on the size of your home office.
Wages. Wages to employees are deductible expenses. If your business structure requires you to pay a wage to yourself, this is also tax deductible—though note that this deduction only applies to business taxes, and you’ll still have to pay personal income taxes on those wages.
There are, of course, many more possible business expenses you could deduct. The main thing to keep in mind is the qualification that your expenses should be things that contribute directly to the operation of your business, towards the end goal of generating revenue. The IRS further clarifies that they must be “ordinary and necessary” to your business.
For an exhaustive list of possible expenses, we recommend that you check out the official IRS documentation.
There are some best practices that, while not necessarily requirements, will help you immensely in your day-to-day business.
When it comes to records, and especially financial records (and especially those that might involve the IRS), digital is almost always the way to go. It’s easier to verify your numbers when handwriting is taken out of the equation, and it helps prevent things from getting lost.
There are two basic strategies for digital expense recording: spreadsheets and dedicated accounting software. Spreadsheets are popular because they’re multifunctional and generally free or affordable. Most businesses will likely have some sort of office suite that includes spreadsheets available, and they work reasonably well when you have a smaller number of transactions.
Specialized software, however, is generally much easier to use and can offer a number of features that make the whole process simpler. These features can include automatically categorizing expenses, automatically breaking up and calculating your expenses and income by month or quarter, and applying rules to future entries. All this helps save time and ensure accuracy, freeing you up to focus on other aspects of your business.
If you’re ever unsure about whether you should keep a record of something—keep it! It’s always better to have too much saved than to have the IRS come calling and find out that you don’t have records of a major purchase. That means all of those small business receipts should be filed.
This is another area where going digital can help. Digital storage space has never been more plentiful, and it’s easy to add more. Physical records, on the other hand, can quickly get out of control if you’re trying to keep everything.
Our final tip might actually be the most important. We highly—highly—recommend keeping a hard separation between your personal finances and your business finances. This advice applies even to freelancers with otherwise simple financial processes.
There are a few reasons for this. First, it’s much easier to track your business’s actual income and expenses when you don’t have to worry about sorting through your grocery store and entertainment purchases.
Second, it makes tax time much simpler. You can quickly pull up a list of your expenses and not need to worry about whether they’re business-related. Tax time can be stressful enough—let’s not make it worse than it has to be.
Finally, depending on the way your business is structured, you may be required to keep your personal and business finances strictly separate. When in doubt, the safest bet is always to consult with a licensed professional.
You’ve got questions—we’ve got answers. Here are a few of the most common questions about self-employed expense reporting.
Throughout the year, you’ll want to record your small business expenses somewhere secure. You should also keep your receipts as records of the transactions. This can be done using a small business receipt app or accounting software.
When tax time comes around, you then report your income by deducting your business expenses from your business income. You’ll generally have to pay income tax on this difference.
Note that this exact process can vary depending on the exact way your business is structured. The above is a fairly simplified version of the process that applies to most sole proprietors, freelancers, and solopreneurs. If you ever feel unsure about something, it’s always best to consult a qualified small business accountant or tax professional.
The IRS defines small business expenses as the ordinary and necessary costs of operating your business. They’re things that directly contribute to you providing a product or service that generates revenue for the business.
Some examples of common expenses for self-employed individuals include:
Marketing and advertising services
Bank and payment processing fees
Mortgage or rent on office space (including the portion of your home used as a home office)
Office supplies, equipment, and maintenance
Payments and maintenance on vehicles used for the business
This is not an exhaustive list—you can consult the IRS website on business expenses for the full rundown.
Two of the most common ways of keeping track of expenses are spreadsheets and expense-tracking software. Spreadsheets are easy to get started with and can be made to perform some complex calculations, but they can also be complicated, unwieldy, and difficult to set up.
Expense software, on the other hand, is usually a more robust and feature-rich solution, and those features don’t require you to write complex formulas to implement them. The best expense reporting software for small businesses also lets you connect your bank account directly so that expenses are automatically recorded and categorized.
Self-employed expenses can be a complicated and stressful topic for some business owners. However, they don’t have to be. By learning what qualifies as an expense and putting a process in place to keep track of them, you can make your life as a small business owner drastically easier—and get a better sense of your actual income at the same time.
If you’re ready to simplify your self-employed expense reporting (and every other aspect of your business’s accounting), give Found a try. Our all-in-one banking solution can save you valuable time. Best of all, it’s free to sign up.
This material has been prepared for informational purposes only.
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