A tax write-off, or in other words, a tax deduction, is a rather helpful option to use by taxpayers. Such taxpayers as self-employed individuals and small business owners get the most out of tax deductions.
This option allows taxpayers to deduce some of their expenses. The IRS defines expenses as anything bought to help run the business to gain revenue. The cost of these items is deducted from the revenue. That way, a company lowers its taxable income and saves money. Some of the simplest examples of write-offs include mileage, rent, mortgage payments, etc.
But how exactly do the write-offs work? Keep reading our article that we prepared for you to learn more about tax deductions and what are their benefits.
Understanding a Tax Write-Off
A tax write-off is an expense that a taxpayer may claim as a tax deduction. When it’s time to pay taxes, taxpayers calculate their taxable income. It’s possible to use a tax write-off to deduct some of the expenses and lower this taxable income.
An expense must be typical for the industry and help a business to operate. In that case, the expense may be written off. The IRS claims that the write-off shouldn’t be 100% necessary, but it does have to be common, and such an expense helps a business successfully perform and generate income.
Typically, business expenses are either fully or partially deductible. It is beneficial for small businesses to try to write off as many expenses as possible since that way, and they reduce their taxable income.
It is only possible to deduct expenses if a business is of a for-profit type. If someone runs a “hobby” business, then it’s not possible to deduct such business expenses to lower taxpayers’ tax burden.
In most cases, small businesses are to calculate and submit Schedule C Form to report their business expenses and lower the taxable income. Keep reading the article to learn more about how write-offs work and what expenses it is possible to deduct and lower the taxable income.
How Tax Write-Offs Work
The main goal of a tax deduction or write-off is to reduce the taxable income when it’s time to report income returns to the IRS. A simple example, a company made $300,000 last year and now has to file taxes. But then the accountant calculated deductible expenses. It turns out that the company may write off $50,000, and now its taxable income is $250,000.
The IRS allows self-employed individuals, freelancers, contractors, and sole-proprietorship owners to write off business-related expenses. For example, if a freelance lawyer uses their car to run the business, they may write off the car mileage. Overall, small businesses may even deduct such expenses as working from home (rent), rent of an office, etc.
Employed individuals also may write off some of their expenses if they use itemized tax deductions. People may deduct such expenses as mortgage interest, charitable donations, and other deductions to lower their taxable income.
Even if a person is using standard deductions, it is still possible to write off some expenses. In this case, an individual would have to check the IRS official website. The IRS sets standard deductions each new year.
The amount of tax deductions a person is allowed to write off depends on the filing status and some other peculiarities. Check the IRS website to see more information.
Tax Write-Off Benefits
The main advantage of a tax write-off is lowering the taxable income. It’s a legal right of every taxpayer to use this option and reduce the taxable income. Experts recommend carefully analyzing and calculating possible deductible expenses as it may lower the amount of money a taxpayer owes to the state. Make sure you keep these calculations since it’s the IRS requirement.
Who may Benefit from a Tax Write-Off?
Most individuals, self-employed people, small businesses, and corporations may deduct their business-related expenses and reduce the taxable income.
Individuals
It is possible to use standard deductions to reduce the individual tax burden. For example, it is acceptable for individuals to write off $12,550 as a single person and $25,100 when filing jointly (when married) in 2021. In 2020, it was $12,400 and $24,800 respectively.
Individuals may also benefit from tax credits. A tax credit is the amount of revenue a taxpayer owes to the federal or state government. It’s a dollar-for-dollar reduction of taxes that a taxpayer owes. The most common credits include such options as the Earned Income Tax Credit, Child Tax Credit, Dependent Care Credit, etc.
The IRS sets different standards depending on taxpayers’ revenues and filing status. It is a good idea to visit the IRS official website to learn more about the tax return and possible deductions.
Self-Employed Individuals
The first thing to note is that no matter what structure your business has, you may still write off business expenses. There is a common misconception stating that if you register a business as a corporation, you get more to write off. In reality, sole-proprietors, partnerships, and all types of corporations can deduct business-related expenses.
Most self-employed individuals register as sole-proprietors. This business structure allows deducting as many expenses as the corporation. It is a good idea to consider asking for the help of professional counselors or accountants when starting a business and then filing taxes. A lot of self-employed business owners don’t know about all the benefits they may use.
For example, it is possible to deduct the full cost of a business’s equipment up to $1,050,000 in 2021, but only in case it is put to use during the very first year. That’s why you should feel free to ask for help since the benefits are too good to ignore.
Small Businesses
Most small businesses such as partnerships, sole-proprietorships, and corporations that have employees may deduct specific business expenses. The common business-related expenses are payroll costs and other expenses needed to run a company.
One of the most important aspects to take into account is keeping books. Even if a business has several employees and a small asset value in the balance sheet, it still has expenses. A small business has several financial operations a day, and it’s important to record everything.
As a result, at the end of a tax year, an accountant will be able to reduce the taxable income of a company as much as possible. Every expense should be recorded as soon as possible. All those business lunches, travel expenses, mileage, and other costs a business pays for may be deducted. Try to keep everything to benefit from tax deductions.
Corporations
The IRS determines that corporations may deduct ordinary and necessary business expenses. There are also current and capital costs that may be deducted.
Current expenses are related to the costs of running and keeping a corporation. These are fully deductible costs. Capital costs are the ones a corporation spends on investments or real estate to generate revenue.
Corporations usually deduct all expenses needed to run a business, for example, rent, office supplies, depreciation, payroll, etc. It’s also common to deduct costs spent on benefits for employees, such as health insurance, tuition, bonuses, awards, sick leaves, etc.
Tax Write-Offs and a Small Business
Small businesses should consider calculating all deductible costs to reduce the taxable income. Here are some of the categories to look at:
- Marketing and advertising.
- Tuition and training.
- Rent and lease.
- Car and truck expenses.
- Contractors.
- Benefits for employees.
- Travel, meals, entertainment.
- Office supplies and postage.
- Other supplies.
- Miscellaneous such as bank fees, wages, etc.
Not calculating all these expenses may dig a big hole in a small business’s budget. It’s recommended to ask for professional aid. With the help of an accountant, a business can significantly reduce its taxable income.
What Expenses can’t Be Written Off?
Some aspects you spend on can’t be written off as deductions. Even some typical write-off categories have specific exceptions that a taxpayer can’t deduct.
This is what you can’t deduct to reduce your tax burden:
- Alimony – if a taxpayer made a divorce agreement after 31st December 2018.
- Roth Individual Retirement Account (IRA) contributions.
- Moving expenses – the only exception is if a taxpayer serves in the military.
- Child support.
- 529 contributions since they could be deductible on state returns.
- Any political contributions.
There are some other interesting exceptions. For example, even though cosmetic surgery is medical care, it doesn’t fall in the same category as dental and medical care and can’t be deducted. Another example is when giving someone money, you can’t consider it as a charitable deduction.
Write-Off Examples
There are quite a few examples of write-offs. For instance, individuals can write off mortgage interest. A taxpayer can deduct interest on the first $750,000 of home loan as long as the house was purchased after 15th December 2017. If a home was purchased till 14th December 2017, then the maximum mortgage interest deduction can reach up to $1 million. But check some other examples below to understand the topic better:
- Example 1. A small cleaning business can deduct car mileage since workers need to travel. The team has eight workers so that the owner may deduct their wages. All cleaning supplies can be written off as well. It’s also possible to write off home office deductions, phone bills, general liability insurance policies.
- Example 2. A web developer works from a home office, and it takes up 30% of the living space. It means that the developer can write off 30% of the rent. The developer pays an accountant to do taxes and writes off the fee. Such costs as advertising, mileage if clients need a personal meeting, professional conferences, meals with clients, etc., can be written off as well.
- Example 3. A freelance photographer has a team that helps set the lights, so their wages can be written off. Mileage and meals with clients are also deductible. Phone bills, home office rent, and specific software can be deductible expenses.
A tax write-off is a tax deduction. Don’t miss out on deductions since they can significantly lower your taxable income.
