What expense category is Background Checks?

In today's business environment, conducting background checks on potential employees, and sometimes on business partners or key clients, is a common due diligence step. These checks help businesses mitigate risks, ensure a safe working environment, comply with industry regulations, and make informed hiring or partnership decisions. The fees associated with these screening services are business expenditures that require proper classification.

Accountants and SMB owners need to understand how to categorize background check costs for accurate financial reporting and tax purposes.

Background Checks Expense Category

Fees paid for conducting background checks for legitimate business purposes are considered Operating Expenses. The most appropriate specific expense category often depends on the context and your chart of accounts structure:

• Recruitment Expense / Hiring Costs: This is a very common category, as background checks are a standard part of the pre-employment screening process.
• Professional Fees: If you use a third-party specialized screening agency or service to conduct the background checks, their fees can be classified here.
• Legal and Professional Fees: Often combined with professional fees, or used if the background check is part of a broader legal due diligence process.
• General and Administrative Expenses: A broader category that can be used if the amounts are not material enough to warrant a separate line item or if no other specific category is preferred.

Using a specific sub-account like "Background Check Fees" under Professional Fees or Recruitment Expenses can offer better visibility into these specific costs. Consistency in categorization is key.

Some Important Considerations While Classifying Background Checks

When handling background check costs, keep these points in mind:

1. Business Purpose: The background check must be conducted for a legitimate business reason. This typically includes:
   
   • Screening job applicants (pre-employment).
   • Due diligence on potential business partners, major vendors, or high-value clients (where financially prudent and legally permissible).
   • Checks required by law or regulation for certain industries or roles.
   • Background checks conducted for personal reasons are not deductible business expenses.
2. Ordinary and Necessary: Costs for reasonable background checks related to hiring or significant business relationships are generally considered ordinary (common and accepted) and necessary (helpful and appropriate) business expenses.
3. Legal Compliance: Businesses conducting background checks must comply with all applicable laws, such as the Fair Credit Reporting Act (FCRA) in the U.S., which governs how consumer reports (including background checks) are obtained and used. This involves obtaining proper consent and following specific procedures. While not an accounting classification issue, it's a critical legal aspect of the activity.
4. Recordkeeping: Maintain detailed records. Keep invoices from the background check service provider that clearly state who was checked (ensure compliance with privacy laws for storage), the type of check performed (e.g., criminal, employment verification), the date, the cost, and proof of payment.

Examples of Background Checks Expenses

Common types of background check services and associated fees include:

• Criminal history searches (local, state, federal).
• Verification of past employment.
• Verification of educational degrees and qualifications.
• Credit history reports (for positions with financial responsibility, subject to FCRA and consent).
• Motor vehicle record (MVR) checks (for positions involving driving).
• Drug screening tests (often conducted in conjunction with background checks).
• Professional license verification.
• Identity verification services.
• Fees paid to third-party consumer reporting agencies or specialized background screening companies.

Tax Implications of Background Checks Expenses

• Deductibility: Fees paid for background checks conducted for legitimate business purposes (such as hiring employees or necessary due diligence on business partners) are generally tax-deductible as ordinary and necessary business expenses.
• Timing of Deduction: These costs are typically current operating expenses and are deductible in the year they are paid or incurred, depending on your business's accounting method (Cash or Accrual).

Where to Report (Schedule C): For sole proprietors, background check fees are reported in Part II (Expenses) on Schedule C (Form 1040):

• Line 17 ("Legal and professional services"): This is a common line if using a third-party screening agency.
• Line 27a ("Other expenses"): Also frequently used, specifying "Background Check Fees," "Recruitment Expenses," or "Screening Fees."

IRS Publications 535 and 334 confirm the deductibility of ordinary and necessary business expenses, including professional fees and other general operating costs.

How Fyle Can Automate Expense Management

Managing payments for background check services requires proper documentation and categorization. Here’s how Fyle can help:

• Capture Invoices and Payments: Track payments made to background check providers via company credit card using Fyle's real-time feeds. Easily manage invoices paid via other methods by uploading the invoice and attaching proof of payment within Fyle.
• Centralize Documentation: Store service agreements or detailed invoices from screening providers digitally, linked directly to the expense transaction in Fyle. This keeps all relevant documentation organized and accessible for audits or reference.
• Consistent Categorization: Use Fyle to reliably categorize background check fees under "Recruitment Expense," "Professional Fees," or your business's designated account, ensuring consistency.
• Integration with Accounting Software: Fyle seamlessly syncs the categorized expense data to your accounting system (QuickBooks, Xero, NetSuite, Sage Intacct), reducing manual data entry and ensuring your financial records are accurate and up-to-date.

Background check fees incurred for valid business purposes are generally deductible operating expenses, typically categorized under Recruitment, Professional Fees, or as a specific "Background Check Fee." Ensuring compliance with applicable laws like the FCRA and maintaining thorough documentation are crucial. 

Utilizing expense management tools like Fyle can help streamline the tracking, documentation, and categorization of these important due diligence costs.