What Is a Write-Off?
A write-off is a business expense that can be deducted from taxable income. By writing off qualified expenses, businesses can lower their tax bill. This allows them to retain more of their hard-earned profits.
Write-offs are different from write-downs, which are special accounting adjustments performed to reduce the value of an asset due to changes in its useful life, expected productivity, or dramatic changes in its market value.
In this article, we’ll explore what constitutes a valid write-off, how write-offs work, most common types of write-offs, and more. Let’s get started.
What Qualifies as a Business Write-Off?
A business expense qualifies as a write-off if it meets the criteria established by the local tax authority of the country where the business is based in.
In most cases, the expense must be both ordinary and necessary. This means that it emerges as part and during the natural course of operating the business and it is appropriate for the industry.
Second, the expense has to be directly related to generating business income. If the purpose is partially personal, that portion can’t be written off.
Finally, you must keep proper documentation like receipts and mileage logs to justify that the expense can be deducted from the business taxable income. If audited, the business needs to provide evidence that proves the purpose of the expense.
Some common examples of expenses that businesses write off include:
- Vehicle depreciation.
- Home office expenses.
- Office equipment and supplies.
- Professional fees like legal and accounting.
- Advertising and marketing.
- Travel and meals (subject to limits).
- Training and continuing education.
- Insurance (e.g. liability, health).
- Interest payments.
- Utilities and phone bills.
As you can see, many costs incurred in running a small business can qualify as write-offs. The specific types of expenses that do not qualify vary from one jurisdiction to the other.
How Do Write-Offs Reduce Taxes?
Writing off expenses lowers a business’s taxable income. This is best explained with an example.
Let’s say a boutique brought in $100,000 last year in revenue. After writing off $30,000 in qualified business expenses, its taxable income would be $70,000. If its applicable tax rate is 25%, writing off those expenses would reduce the resulting tax bill from $25,000 to $17,500.
That’s a $7,500 tax savings!
In the United States, sole proprietors report write off expenses by using a form called Schedule C and face some limitations in regard to the amount they can deduct. Other corporate structures like LLCs, S-corps, and C-corps must abide to different rules.
What Records Should Be Kept for Write-Offs?
To qualify for tax write-offs, it is very important to keep accounting records adequately. The IRS requires documentation that proves that expenses meet its “ordinary, necessary, and business-related” criteria.
For travel, meals, entertainment, vehicle use, and other expenses, businesses must keep detailed mileage logs, calendars, receipts, and purpose explanations. Accounting software and apps can be used to keep track of a company’s income and expense items accurately.
For assets with a useful life longer than a year like computers or heavy equipment, records related to their cost, date of purchase, and estimated useful life must be kept. These fixed assets can be depreciated over time and the resulting charge can be deducted from the business’s taxable income.
Health insurance contributions, retirement plan deposits, inventory purchases, rent and utilities payments, supplies purchases, and other routine business expenses must also be properly documented to claim them as deductible expenses.
This documentation, when properly kept and organized, can facilitate the process of filling out IRS forms and survive audits without incurring penalties.
Common Small Business Write-Offs
Running a small business opens the door to a wider array of deductions compared to employees with W-2 income. Here are some common write-offs that freelancers, shop owners, restaurateurs, contractors, and other small business owners can utilize to reduce their tax bills.
Home Office Deduction
If you use a portion of your home exclusively for business, consider writing off a percentage of its associated costs like rent, utilities, insurance, security system fees, and repairs. There are two calculation methods to determine the amount that can be deducted – the simplified and regular methods.
Health insurance premiums paid to cover the owner of the business, spouse, dependents, and employees can generally be written off as a business expense. Rules differ depending on the business structure but, in most cases, this is a deductible expense.
Computers, machinery, tools, furnishings, and other equipment purchased for the business can either be expensed immediately or depreciated over time. Section 179 and bonus depreciation provide additional tax deductions related to this item.
If the owner of the business uses a car or truck for its day-to-day operations, writing off vehicle expenses like gas, repairs, insurance, lease payments, and depreciation can result in significant tax savings. Keep meticulous mileage logs to have a record of business vs. personal expenditures in case there is an audit.
To stay sharp and up to date with the most relevant trends, business owners may attend conferences, buy books and magazines, or take classes. These expenses help maintain and improve their professional skills and are deductible as long as they can be associated with the company.
Overnight stays away from home for a business purposes like meeting clients, checking on locations, and attending events can be written off as well. Subject to limits, airfare, lodging, 50% of meals, tips, luggage fees, laundry, parking, and cab rides usually qualify.
If the owner secured a loan or line of credit for the business, the interest payments associated with this financing instrument are typically tax deductible. However, it is worth noting that the loan’s proceeds must be used for legitimate business expenses.
Entrepreneurs create brand awareness and attract customers through materials and initiatives including like printed advertising, online directories, Google/Facebook ads, flyers, direct mail, signage, sponsorships, podcast appearances, etc. These advertising campaigns are commonly considered tax deductible as well.
Many more business expenses could be listed. In most cases, business owners will benefit from working with a tax professional to utilize all deductions allowed for their venture to save money.
Write-offs play a key role in reducing a business’s tax liability and help owners retain a larger stake of their hard-earned profits. You now understand what constitutes a valid write-off, how they work, documentation required, and some common examples. Leverage this knowledge so your business fully benefits from all permissible deductions.