Tax Deductible Business Expenses for Startups
Business Expense Categories for Startups: A Complete Guide to Maximize Your Tax Deductions
When you’re starting a business, every dollar counts. That’s why it’s so important that you know about common IRS tax-deductible business expense categories so you can maximize your deductions while minimizing your tax paid.
Even if you don’t need those deductions now, these deductions will pay off for you down the road — whether it is today or a couple of years from now when you’re more profitable.
This guide will give you a primer on the most common tax-deductible business expense categories a startup is likely to need. We’ve helped countless startups like yours maximize their tax savings, and by using this guide, you can be sure that you’ll be arming your startup with one of the most important tax advantages available to any new business.
What are tax-deductible business expenses?
Tax-deductible business expenses are costs that are essential to running your business and that the US government will essentially help you pay for. Instead of writing you a check for these costs, the government offers business owners a tax deduction for any essentials they spend money on.
For a business expense to be tax deductible, the IRS requires that it is both “ordinary” and “necessary” (under IRC 162) to the running of your business. Ordinary expenses are those that are common and accepted in your industry, while necessary expenses are those that are helpful and appropriate for your business.
Contrary to popular belief, there isn’t a set list of deductible expenses from the IRS. Instead, the burden of proof lies with business owners to justify that their expenses meet these criteria. For example, what’s ordinary and necessary for a tech startup may differ significantly from what’s deductible for a retail business.
What are tax deductions?
When you claim business expenses, you get a tax deduction, but what does this mean exactly? A tax deduction is like a coupon for your taxes; it saves you money on taxes you owe, but it can’t be used to generate a refund.
For example, if you owe $10,000 in taxes and have deductions worth $15,000, you would pay $0 in taxes but would not get a $5,000 check for the difference.
However, that $5,000 would not just disappear, either. The tax code allows you to carry over excess expenses in a few different ways, so you can essentially use these deductions in years when it would be most beneficial to you. Many of the world’s most successful businesses have produced large operating losses that are carried over to offset future profits.
18 tax deductible business expense categories
As we’ve mentioned before, there’s no exhaustive list of business expense categories. Instead, read through this list of common business expense categories, and then work through your own expenses with a CPA or tax expert to determine what you can claim.
1. Advertising and marketing
Costs for promoting your business, such as digital ads, social media campaigns, or traditional media. Every dollar spent on building brand awareness is typically deductible.
Remember, personal expenses disguised as marketing won’t qualify. If you aren't sure whether your marketing efforts qualify, reach out to a tax advisor to get further clarification
2. Business meals
Expenses for meals during business meetings or travel are 50% deductible. However, entertainment expenses are generally non-deductible, so differentiate clearly between meal and entertainment costs.
For example, if you bring a client to a sports game, the tickets are not deductible, but the meals you buy at the game certainly could be.
3. Rent and office space
Lease expenses for your office, co-working space, or even a home office (if you qualify) are deductible. Document the business use of these spaces to avoid complications, especially if the space is used for multiple purposes.
4. Business use of personal assets
If you use personal items like your car or phone for business, you can deduct a portion of these expenses. This is done through an accountable plan. Accurately track the business use percentage to claim the correct deduction.
5. Employee benefits
Costs for health insurance, retirement plans, or other benefits are deductible. For startups with a small team, structuring these benefits correctly can maximize deductions and support employee retention. You should check with your tax advisor to discuss the taxability of these benefits for owners and certain equity holders.
6. Depreciation
The cost of tangible assets like computers and equipment is deductible over time through depreciation (a cost recovery system). This can be complex, so work with a tax advisor to maximize the benefit without triggering recapture issues.
7. Continuing education and training
Education and training costs are generally deductible if the education maintains or improves skills needed in your current business. However, education for a new trade or business won’t qualify.
8. Startup costs
The IRS allows a deduction of up to $5,000 when it comes to startup costs in the first year of business, with any remaining costs amortized over 15 years. Qualifying expenses include market research, legal fees, and initial advertising costs before you have officially launched.
9. Software and technology
Subscription costs for software and online tools used in your business are deductible. This includes accounting software, project management tools, and industry-specific platforms.
10. Interest and bank fees
Interest on business loans and fees associated with business bank accounts or credit cards are deductible, but personal finance charges are not.
11. Utilities
Basic utility costs are straightforward deductions but require careful documentation, especially with the ongoing remote work trend. Eligible deductions include electricity, gas, water, and internet services — anything that is essential for operations.
For home-based businesses, calculate the percentage of utilities used for business versus personal use. Modern businesses should also consider essential communication costs, such as business phone lines and dedicated internet services.
12. Office supplies
While seemingly minor, office supply expenses can add up significantly. These are fully deductible when used exclusively for business purposes. Keep detailed records of purchases, even small ones.
Remember that supplies differ from equipment — they're consumable items used in daily operations, like printer paper or pens.
13. Business insurance
Insurance premiums are generally deductible if they're ordinary and necessary for your business. This includes liability insurance, professional liability coverage, and workers' compensation insurance.
14. Business licenses and operating permits
Required licenses and permits are necessary expenses that vary by industry and location. These costs are typically fully deductible in the year they're paid.
15. Membership fees
Professional membership dues are deductible when they benefit your business operations. This includes trade associations, professional organizations, and chambers of commerce.
Be aware that social club memberships, even if used partially for business, are generally not deductible.
16. Professional services
Fees paid to professionals like lawyers, accountants, and consultants are deductible business expenses. These costs often provide long-term value and help ensure compliance.
17. Travel expenses
Business travel expenses are deductible when they're ordinary and necessary for your business. This includes airfare, lodging, and local transportation when traveling outside your tax home.
Maintain detailed records of the business purpose for each trip, including itineraries and meeting notes. Remember that the rules for international travel can be more complex, so consult your tax advisor for guidance.
18. Payroll
Payroll expenses, including wages, salaries, and commissions, are typically your largest deductible expense. This category requires careful management and compliance with various regulations, so be sure to check with a tax professional before you claim a deduction.
State-specific considerations
While federal deductions get most of the attention, state taxes can significantly impact your startup's financial health. Some states conform closely to federal rules, while others have unique tax structures. California and New York are notorious for not always conforming to the Federal Tax Code, while others mirror it exactly.
For instance, Nevada, Texas, Ohio, and Washington levy gross receipts taxes instead of traditional corporate income taxes, affecting startups that are not yet turning a profit.
For 2024, several states have made changes to corporate tax rates:
- Arkansas: Reduced the top marginal rate to 4.8%.
- Iowa: Lowered the top rate from 8.4% to 7.1%.
- Nebraska: Phased reduction to a flat 3.9% by 2027.
- New Jersey: The top rate dropped to 9% after a temporary surcharge expired.
Staying informed about these tax rate changes will help you choose the best state for incorporation and navigate multi-state tax obligations as you grow.
4 tips for managing your startup’s business expenses easily
Managing business expenses efficiently isn't just about saving money — it's about creating systems that scale with your business while keeping you compliant and prepared for tax season. Here's how to get started:
1. Keep detailed records
Many do not realize that the Tax Code actually requires books and records. Having accurate accounting from day 1 will be a smart investment in the long term.
Here are some tips to help you keep better records:
- Document the business purpose of each expense at the time it occurs, especially for travel and meals
- Maintain a digital backup of all important documents
- Keep records for at least seven years, as this covers the statute of limitations for most tax audits
- Use expense management software that can sync with your bank accounts and credit cards
2. Always separate business and personal finances
Use dedicated business accounts to avoid mingling personal and business expenses. This separation is crucial for accurate record-keeping and tax reporting.
Here are some common mistakes we often see when it comes to keeping personal and business expenses separate:
- Using personal credit cards for business purchases
- Paying personal bills from business accounts
- Not maintaining separate accounts for different business entities or ventures
- Not keeping detailed logs when using personal assets (like vehicles) for business purposes
3. Use AI automation to categorize expenses
With new advances in automation and machine learning, AI can be one of your biggest assets when it comes to keeping on top of your business expense categories.
For example, with Digits, our AI platform will learn from your common business deductions and begin to categorize your expenses for you. If it’s ever uncertain, it will flag it for you so it can continue to learn exactly what should be categorized as what for your business.
Not only will this save you time, but it can also save you the cost of hiring a bookkeeper to do this job for you.
Other advantages of using Digits include:
- Smart flagging of unusual spending patterns or potentially mis-categorized expenses
- Custom reporting that helps you better understand your finances
- Automated bill payments for a simplified approval workflow
4. Consult a tax advisor
As your business grows, your tax situation will become more complex. A professional can help you identify additional deductions and certain tax credits at the federal and state levels and plan for future tax obligations.
A professional tax advisor can help you by:
- Reviewing your expense categories to ensure they align with current tax regulations
- Identifying industry-specific deductions you might be missing
- Advising on the tax implications of business decisions before you make them
- Helping you understand which expenses require special documentation
- Preparing for and responding to any IRS inquiries or audits
Save money with expert tax advice
Understanding and maximizing your deductible business expenses is a foundational tax strategy for startups and small businesses. If you have excess expenses, they will simply carry forward with you, so do not overlook deductions that you are entitled to.
Once you reach profitability, these deductions reduce taxable income, preserve cash flow, and provide funds that can be reinvested into the business. By keeping thorough accounting records and staying informed about both federal and state tax regulations, startup founders can navigate these complexities effectively and focus on growth.
Tax planning isn’t just for tax season. Proactive, year-round management of your business expenses is the key to long-term success. If you are interested in learning more about active tax management, reach out to Digits today. Our team can help you save money, increase your deductions, and save you headaches come tax time.
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