How to Categorize Expenses for Your Startup
I’ll cut to the chase — reverse engineer your income tax return. If your expense categories match your income tax return categories, you will be able to effectively copy / paste the data when filing your taxes. This may seem ultra simplistic, and that’s because it is!
Of course there are categories that you will want to break down and analyze. The details matter. The specifics matter. But when it comes to broad categories of expenses, I like to use Form 1120S — U.S. Income Tax Return for an S Corporation. I should mention these categories are mostly the same across all business forms such as Partnerships or Limited Liability Companies.
I like to confine myself to the categories I’ve highlighted and by doing so save the hassle of extra forms and attachments. I’ll briefly describe each category and how I use it.
Discounts (Returns and Allowances) —
Returns are obvious. Allowances are coupons or discounts your company offers off of the retail price. If you have an item for $20 and someone uses a $5 coupon, you still count the gross sales as $20 and deduct the $5 in this category. I label this category discounts because my business is a service so there are no returns, only promotions, coupons, and other discounts.
Sourcing / Inventory (Cost of Goods Sold) —
I don’t use this category much because I’m not selling goods but rather a service. However, if I outsource my service, I place those expenses into this category. For example, someone places a laundry order, I go get their laundry and take it to someone else to wash, instead of washing it myself. I deduct that expense as the cost of the goods sold, namely, how much it cost me to have the laundry done.
For most businesses this category is very important especially if they keep any sort of inventory.
Compensation of Officers —
Self explanatory.
Labor (Salaries and Wages) —
This category only comes into play once you have employees and a payroll. For most startups that will be after they’ve reached product — market fit.
Operations (Repairs and Maintenance) —
I renamed this category to operations because I wanted it to capture more than just repairs and maintenance. I want to include everything we have to pay to keep the lights on and the water running. This includes the vast majority of our monthly utilities, which as far as I’m concerned, involve the maintenance of the company.
Rents —
Self explanatory.
Taxes and Licenses —
Self explanatory.
Interest Paid —
Self explanatory.
Advertising —
This is such a broad category that most startups will want to break it down and really analyze the ROI of their different advertising channels. I have 2 major sub-categories — online ads and print ads. I’m sure more sub-categories will pop up as my business matures. Still all of those expenses will be classified here for tax purposes.
Pensions, Plans, and Profit Sharing —
Self explanatory and probably will not come into play until a couple of years into the company’s existence.
Employee Benefits Programs —
Self explanatory.
Of these categories, my business mostly uses only 4 of them right now — Discounts, Operations, Taxes & Licenses, and Advertising. That vast majority of my expenses fall into these categories since I don’t have a physical location or employees yet. Hopefully I get both as my business grows.
I hope this helped you to understand how the IRS looks at businesses and guides you in determining how to create your own expense categories.
To Do List Update
- Create a Re-Order button for website that makes it easier for repeat customers to order.
- Create a Feather publication on Medium.
- Obtain a virtual office address.
- Add business to Google and other search engine maps.
- Create more quotes and memes for Instagram.
- Document the back-end process from order to delivery including calendar.
- Create Welcome Packages for new customers.
- Write a template email for reaching out to influencers to offer free service for shoutouts.
- Create a loyalty program.
This story is part of a series documenting the journey of a 2016 Dallas startup called Feather. For your reference here is the Table of Contents for the series.
Previous Story: Why I’m All-in on Instagram Ads
Next Story: How Medium’s Design Solved My Problem
Take a closer look on Instagram —
Thanks for reading!
