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What is a Tax Write Off and Why Does it Matter?
As a small business owner, you’ve probably heard of tax write offs. You’ve probably thought to yourself, “What is a tax write off?” because true story, when do we ever learn about stuff like taxes?
How about today?! Well, you’re in luck because today I’m teaching you all about what tax write offs are and why they matter.
Keep reading because you’ll know exactly how tax write offs affect your business finances, your taxes, and your tax payments. Plus, you’ll learn how to tell if an expense is a tax write off… and if it’s not.
I’ve been teaching small business owners about business finance for over 10 years, so if the idea of learning about taxes scares you, don’t worry. Taxes are like the mean girls in high school – they look a lot more intimidating than they actually are. So, first thing’s first.
Why Should I Love Write Offs Work?
So, first thing’s first.
Write offs, also known as tax deductions, are an absolute dreamboat on your taxes because they lower your tax liability. That means that they lower how much your final tax bill will be and how much you owe the government.
Here is the reason why these necessary expenses are called write offs or tax deductions: you can deduct these expenses from your total revenue, which gives you your taxable profits. That, my friends, is what you’re taxed on.
You’ve got your total revenue, which is just a fancy way of saying all your income. Then you’ve got your tax deductions, which are the tax write offs. Finally, you’ll have your taxable profits, which is essentially your personal income.
Here’s what the equation looks like:
Total Revenue – Tax Write Offs = Taxable Profits
So, the more tax deductions you have, the less you’re going to pay in taxes.
What is a Tax Write Off?
Now that you know why you should love and adore tax write offs, let’s answer the question, “WHAT is a tax write off?”
A tax write off is also known as a tax deduction. The IRS defines a tax deduction as an ordinary and necessary expense for your business, which sounds a little ambiguous.
So, let’s break that down.
Ordinary means that it’s an expense that’s pretty typical for a business. Some examples are advertising expenses, travel, meals, and supplies. Most businesses will have these types of expenses, which is why they’re called ordinary.
Necessary is a little bit trickier. It’s an expense that’s necessary for you to operate your business. Now, different industries have different needs. So, while ordinary expenses are pretty much the same across all types of businesses, necessary expenses vary.
A photographer’s necessary expenses will be photography supplies. A painter’s necessary expense will be paint brushes. A hair stylist’s necessary expenses will be shampoo and hair brushes. Basically, depending on the type of business you have, what is deemed necessary will be different than your biz bestie’s.
There are also tax write offs that I call split deductions. Split deductions are expenses that are both personal expenses (as in not tax deductible) and business expenses. With split deductions, you can only write off the business portion of the expense. The personal portion isn’t deductible. You can read so much more about split deductions here.
So, aren’t all business expenses tax write offs?
Ummmmmmm…. No. Just because it’s an expense for your business doesn’t mean that the IRS will classify it as a tax write off. For example, under the new tax law, client entertainment is no longer deductible. So, if you take your client out to My Little Ponies on Ice, you can still consider it a business expense, internally. BUT you can’t claim it as a tax deduction.
Most business expenses will be tax deductions. But it’s important to know that not every single expense will fall under the necessary and ordinary umbrella.
How Do I Know if I Can Write it Off?
So we’ve talked a lot about necessary and ordinary expenses, but it can still feel really confusing when you’re trying to figure if something really is a business expense. Because, real talk, as self-employed people, SO MUCH of our personal lives are intertwined with our business.
And of course, we don’t want to be lying on our taxes about our deductions or writing things off that really aren’t business expenses.
So, how do you make sure you’re writing off the right expenses?
First, if it’s a legit business expense, don’t fear the tax deduction! I’ve talked to so many business owners who aren’t writing off legitimate business expenses because they’re afraid of the IRS. Seriously, if it’s necessary and ordinary for your business, then take the deduction.
If you’re unsure if an expense is actually necessary and ordinary, here are some questions you can ask yourself regarding your expenses:
Does it have to do with my business?
Now, obviously, the answer should be yes. If it’s not a yes, then you have no business trying to make it a tax write off.
What does it have to do with your business?
Think this through. How is this expense related to your daily operations, performing your services, or selling your products?
Is it an expense that the IRS has deemed non-deductible?
I’ve got a blog post that talks about business expenses that people *try* to write off, but really can’t.
Can I justify it to an IRS auditor?
When you get audited, you have the chance to explain suspicious expenses to your auditor. If you were talking to an auditor, could you make a compelling case for why this expense is related to your business? When I say compelling, I’m not talking about a bunch of mental gymnastics to justify something. I’m talking about a really clear, straightforward answer for writing it off. If not, you shouldn’t write it off.
If you’re still unclear about an expense, keep track of it but also make a note to talk to a tax professional about the expense.
Want to learn more about tax write offs? I’ve got all the goods linked here!
- 7 Awesome Write-Offs that Solopreneurs Need to Know
- 6 Overlooked Tax Deductions for Brand New Businesses
- 7 Tax Deductions That You Need to Start Writing Off Immediately
These posts will give you an idea of the types of deductions you could be taking for our small business. AND I have something super special for you – my Biz Finance Survival Kit. It’s free and not only comes with a tax write offs cheat sheet, but also with four other cheatsheets and checklists for your small business.