What is an 'Expense'
An expense consists of the economic costs a business incurs through its operations to earn revenue. Businesses are allowed to write off tax-deductible expenses on their income tax returns to lower their taxable income and thus their tax liability. Common business expenses include payments to suppliers, employee wages, factory leases and equipment depreciation, but the Internal Revenue Service has strict rules on which expenses business are allowed to claim as a deduction.
BREAKING DOWN 'Expense'The term "expense" also operates as a verb, and it means to write off an expense. For example, a freelance writer may expense the cost of buying writing utensils for his business, or the executive may expense the cost of taking his clients to dinner because the group discussed business at the table.
Deductible Business Expenses
According to the IRS, to be deductible, a business expense must be both ordinary and necessary. Ordinary means the expense is common or accepted in that industry, while necessary means the expense is helpful in the pursuit of earning income. Business owners are not allowed to claim their personal, nonbusiness expenses as business deductions.
Accountants record expenses through one of two accounting methods: cash basis or accrual basis. Under cash basis accounting, expenses are recorded when they are paid. For example, if a business owner schedules a carpet cleaner to clean the carpets in his office and the cleaner invoices the company for the service, a company using cash basis records the expense when it pays the invoice. Under the accrual method, however, expenses are recorded when they are incurred, and to continue with the above example, the business accountant records the carpet cleaning expense when the company receives the service.
The IRS treats capital expenses differently than most other business expenses. While most costs of doing business can be expensed or written off against business income the year they are incurred, capital expenses must be capitalized or written off incrementally.
Capital expenses are typically large expenditures considered investments into a company. They include business startup costs; business assets such as real estate, vehicles, equipment and patents; and improvements such as putting a new HVAC system into a building. Rather than writing off these expenses in the year they are incurred, business owners must write them off slowly over time. The IRS has a schedule that dictates the portion of a capital asset a business may write off each year until the entire expense is claimed. The number of years over which a business writes off a capital expense varies based on the type of asset.