What expense category is Electricity?

Note on IRS Publications: Guidance on deducting electricity costs comes from general business expense rules for utilities found in IRS Publication 334 (Tax Guide for Small Business, 2024) and Publication 535 (Business Expenses, 2022). These publications also touch on including utility costs in Cost of Goods Sold or capitalizing them under Uniform Capitalization Rules for certain businesses.

Electricity is a fundamental operating cost for nearly all businesses. Understanding how to categorize and deduct these costs correctly is necessary for accurate financial reporting and tax compliance.

How the IRS Views Electricity Expenses

The IRS generally views electricity costs incurred for business operations as deductible utility expenses. However, the specific tax treatment can vary based on how the electricity is used:

• General Business Operations (Offices, Retail, Services): Electricity used for lighting, powering computers, heating/cooling general workspaces, etc., is typically deductible as a Utilities expense in the year paid or incurred.
• Manufacturing/Production: Electricity directly used in a manufacturing or production process might be treated as factory overhead. These costs are often included in the calculation of Cost of Goods Sold (COGS) or may need to be capitalized into the cost of inventory under the Uniform Capitalization Rules (UCR), rather than deducted immediately as a utility expense.
• Home Office: The business portion of electricity costs for a qualifying home office is deductible, usually allocated based on square footage or another reasonable method.

Relevant IRS Publications:

• Publication 334 (Tax Guide for Small Business, 2024): Lists "Utilities" as a deductible expense and mentions power costs as potential factory overhead included in COGS.
• Publication 535 (Business Expenses, 2022): Explicitly lists "heat, lights, power" under deductible Utilities. Discusses potential inclusion in COGS or capitalization under UCR. (Note: UCR rules are complex, apply to certain producers/resellers, and have exceptions for small businesses meeting gross receipts tests).

What Expense Category Should Electricity Costs Fall Under?

For Internal Accounting: You might use categories like:

1. Utilities
2. Electricity
3. Production Costs - Utilities
4. Overhead Expenses

For Tax Purposes (IRS Classification):

1. Utilities Expense: For most non-manufacturing/non-producing businesses.
2. Cost of Goods Sold: For electricity included in factory overhead for manufacturers/producers (if not capitalized under UCR).
3. Capitalized Costs (Inventory/Asset Basis): For electricity costs required to be capitalized under UCR by certain producers/resellers.

Electricity Expense Use Cases and Tax Categorization

1. Electricity bill for a retail store or office: Deductible Utilities Expense.
2. Electricity used to power machinery in a factory: Include in Cost of Goods Sold (as factory overhead) or Capitalize under UCR, depending on applicability.
3. Electricity for a qualifying home office: Deductible Utilities Expense (business portion only) as part of the home office deduction.
4. Portion of home electricity bill related to personal use (even with home office): Not Deductible.

Categories to Avoid While Categorizing Electricity Expenses for Tax Purposes

1. Deducting Personal Use Portion: The part of your electricity bill attributable to personal use is never deductible. Allocation is required if business and personal use share a meter (e.g., home office).
2. Incorrectly Expensing Production-Related Electricity: Manufacturers and certain producers must evaluate if electricity costs should be included in COGS or capitalized under UCR, rather than simply deducting them as a Utilities expense.
3. While others may suggest categories like "Production Cost" or "Overhead," the correct tax mechanism might be COGS inclusion or UCR capitalization, not a direct expense line named "Production Cost."

Key Considerations for Classifying Electricity Expenses

1. Nature of Business: Are you primarily providing services/retail (likely Utilities expense) or manufacturing/producing goods (consider COGS/UCR)?
2. Uniform Capitalization Rules (UCR): If you produce property or acquire property for resale, determine if UCR applies to you (based on business type and gross receipts). If so, electricity used in production or related to inventory storage might need to be capitalized instead of expensed. (Small businesses with average annual gross receipts under the threshold - $30M for 2024 per Pub 334 - are generally exempt from UCR for resale inventory).
3. Home Office Allocation: If claiming a home office deduction, use a reasonable method (like square footage) to allocate electricity costs between business and personal use.
4. Record-Keeping: Keep copies of utility bills showing usage and costs.

Tax Implications of Electricity Expenses 

1. General Deduction: Electricity costs for general business operations (lighting, office equipment, heating/cooling non-production areas) are typically deductible as Utilities expense in the year paid or incurred.
2. COGS/Capitalization for Producers: For manufacturers/producers, electricity used in production may be included in COGS or capitalized under UCR, affecting the timing of the deduction (recovered when inventory is sold or through depreciation if capitalized to a self-constructed asset).
3. Personal Use: No deduction is allowed for the personal use portion of electricity costs.

How Fyle Automates Expense Categorization and More!

1. Automated Expense Tracking: Submit electricity bills easily via Text, Email, Slack, or the Fyle app. Fyle's OCR can extract key details like vendor name, billing period, and amount.
2. Real-Time Card Reconciliation: Track utility payments made automatically via company card with Fyle's real-time feeds, simplifying reconciliation.
3. Automated Expense Categorization: Set up rules to automatically categorize payments to specific utility providers (e.g., Con Edison, PG&E) as "Utilities," ensuring consistent coding linked to your GL. Rules could potentially separate costs based on location/meter if needed for COGS/UCR allocation.
4. Seamless Accounting Integration: Fyle syncs categorized electricity expense data directly with accounting software (QuickBooks, Xero, etc.), streamlining bookkeeping.
5. Customizable Approval Workflows: Route utility bills (especially if amounts fluctuate significantly) for review or approval if required by internal controls.
6. Detailed Reporting and Analytics: Monitor utility spending over time, by location, or potentially by department using Fyle's reporting features to analyze trends and budget adherence.
7. Compliance and Audit Trail: Maintain a digital record with attached bills for all electricity payments, providing easy access for audits and tax preparation.

Key Clarification: Fyle helps organize and track electricity bill payments. The business, especially if involved in production, needs to determine the correct tax treatment (current Utilities expense deduction vs. inclusion in COGS vs. UCR capitalization) based on IRS guidelines.

FAQs Around Expense Categorization Of Electricity Expenses

Q1: Can my business deduct its electricity bill? 

Yes, generally. The cost of electricity used for ordinary and necessary business operations (like lighting, running office equipment, heating/cooling) is deductible as a Utilities expense.

Q2: I run a small factory. Is my electricity bill treated differently? 

Possibly. If the electricity is used directly in the manufacturing process (e.g., powering machinery), the cost might need to be included in your Cost of Goods Sold as factory overhead, or potentially capitalized under the Uniform Capitalization Rules (UCR), rather than deducted immediately as a utility expense. UCR applicability depends on factors like your business type and average annual gross receipts.

Q3: How do I deduct electricity for my home office? 

If you have a qualifying home office, you can deduct the business portion of your home's electricity bill. This is usually calculated based on the percentage of your home used exclusively and regularly for business (e.g., based on square footage). This deduction is part of the overall home office deduction.

Q4: What if my business electricity bill includes charges for personal use? 

You can only deduct the portion of the electricity cost attributable to business use. You must allocate the cost between business and personal use and only deduct the business part.