# how do business expenses work?

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I’ve seen mention of classifying purchases as a business expense, and im not certain how it works. what benefit is it to have something be a business expense, and what are the actual qualifications for something counting as one? (I am in the us but it would be interesting to see how this works in other countries as well)

In: 5

it depends on the business. Im self employed, so in a simple explanation if your business makes \$100,000 in one year, you DONT want to pay tax on that 100,000…so you have records of expenses. So 100,000 ‘gross’ income, minus your products, advertising, payroll, utilities, rent etc….so lets say after all the business deductions now your ‘income’ is only 50,000. So you pay tax on the 50,000 not the 100,000.

Let’s say you and I both own roadside lemonade stands. I spend 50 cents to make 20 cups of lemonade and sell them for 25 cents each. You spend \$4 to make 20 cups of chocolate milk and sell them for 25 cents each.

This means we had the same revenue (\$5), but I had a much higher profit of \$4 than your \$1 because my costs were lower.

Now imagine that taxes are based purely on income and ignore costs. Tax man comes around and takes 20% of our revenue. We each have a tax bill of \$1 (20% of our \$5 revenue). This turns my profit from \$4 to \$3 and changes yours from \$1 to \$0.

That seems pretty unfair because you spent more money to make the same revenue. That’s where business expenses come in. A business expense reduces how much money you’re taxed on. Let’s look at the situation again with the same 20% tax rate, but with business expenses considered.

We both claim the cost of our materials as business expenses, which effectively means we’re taxed on proft instead of revenue. I had \$4 of profit, so I pay 80 cents in taxes. You had \$1 of profit, so you pay 20 cents in taxes, which seems a little more fair.

If you have your own business (or in some cases use your own money for a business related expense that is not recompensed by the company you work for), then you can deduct that from your income–which reduces the amount of taxes you have to pay. The rules for what is considered a business expense are fairly extensive, and you increase your odds of being audited by the IRS. Deducting business expenses is also only usable if you itemize your deductions. If you take the standard deduction then the expenses are likely not deductible.

It is also possible that a business expense is paid by an employee and then reimbursed by the company. This is how my company handles most travel and some lunches. You should not try to declare this as a business expense.

As an “S corp” I am required to have a yearly meeting with all my shareholders, despite the fact I am the only member of the entire corporation. So, once a year I take my ex out (she has a business degree) to a nice dinner, and I write it off as a business expense.

I also have to get my taxes done by a CPA (by law) for \$500, have liability insurance (\$600) and pay licensing fees (\$125), then I throw in all the materials and gas I bought, oil changes and repairs, and claim value lost on vehicles and tools that depreciate with time. Work boots but not clothes (unless I get them printed as a work “outfit”), safety glasses and sunglasses but not prescription glasses, my phone, laptop and smartwatch, but not my work radio.

I don’t get the money back, but I don’t pay income taxes on it either. Without the write off, I’d pay about \$30 in income taxes on each \$100 because being self employed kinda sucks. Because I am my own employer, I pay double for social security and medicare.